On the heels of the financial crisis, banks tightened their lending policies and many companies could not qualify for inexpensive fixed-rate loans. Instead, they took on variable-rate loans. Interest payments that fluctuate based on the U.S. prime rate or London InterBank Offering Rate (LIBOR) index are a viable option, as long as rates continue to hover near historic lows. If market indices rise, borrowers with substantial variable-rate loans could be in for a rude awakening.
Just how low are today’s rates compared to historic levels? To put current interest rates into perspective, consider the U.S. prime rate, which is the basis for many companies’ variable-rate loans. It has been set at 3.25% since 2008, its lowest level since the mid-1950s.
By comparison, its 50-year high was 21.5% in 1980. The median prime rate from 1947 to present is 8.75%. The most common prime rate (or mode) is 7.5% over the same period. If the prime rate jumps to 7.5% over the next few years, many companies will be unprepared to absorb the incremental interest expense.