The risks were not explained by many banks!
Just when you thought interest rates had bottomed, we are now heading even lower.
On 4th August 2016, the Bank of England cut the Official Bank Rate from 0.5% to 0.25%. There is even talk of another cut later this year, so we could be heading to 0.1% base rates or even negative (yes they do exists, just look at the European Central Bank, Denmark, Switzerland, Sweden and Japan). Many will be surprised by this latest cut having convinced themselves after March 2009 that base rates couldn’t possible get any lower than 0.5%. Well they have.
So what does this mean?
If you have taken out a business banking loan where the interest rate has been fixed on the loan?
Well, firstly; you will not be able to benefit from the drop in interest rates as you will be fixed for the duration of the loan agreement. So despite the Bank of England encouraging banks to pass on the lower rate to their customers, this will not be possible for those businesses that fixed. Some businesses will be frustrated by this inflexibility in their fixed loan and wished that they had opted for a variable rate loan instead.
So, why don’t these businesses just simply repay the fixed rate business loan and refinance at a lower rate?
Termination Costs ‘break costs’
That brings me to my second point. Many of these fixed rate business loans come with significant termination costs, also known as ‘break costs’. These break costs are not what you would normally expect if you have ever repaid a mortgage early (typically 1-3% of the outstanding mortgage amount) but can be significantly higher, sometimes up to 25-30% of the value of the loan. So if you have £1m loan outstanding and you want to refinance to benefit from lower base rates, it could cost you £250,000 just to break it. We find many cases where this risk was not properly explained by the bank to the business during the sales process of the loan. If it had been, then they wouldn’t have touched the fixed rate product.
The sales process of these fixed rate loans.
I’ve had countless conversations with clients who were told by their Relationship Manger that:
- “interest rates can’t go any lower”
- “interest rates are only heading in one direction, so now’s a great time to fix”
- “you won’t get a better fixed rate deal now”
When you add the implicit trust element to the business-banking relationship, then it is easy to see why many businesses thought it was a great idea to fix. A closer look at the nature of their business, personal circumstances or financial flexibility requirements would indicate that, actually, fixing was not that suitable or appropriate for the business at all.
60,000 SMEs mis-sold?
I am seeing many instances of businesses re-visiting their fixed rate loan agreements – especially customers of Lloyds Bank, Bank of Scotland, Bank of Ireland and Clydesdale Bank. Much of what has been outlined above resonates strongly with these businesses. Furthermore, the FCA estimates that more than 60,000 SMEs could have been mis-sold fixed rate loans.
If the risks of the fixed rate loan were not properly explained to you, then there is a good chance that the loan will have been mis-sold and compensation could be due.
So if you feel frustrated with your current business loan, don’t suffer in silence. It could be some time before base rates start to creep higher again.