What Is the Rate of Interest on a Loan for a Small Business?
Interest rates on business loans represent how much funding you receive from a lender. Interest is expressed as a percentage of the loan amount. The higher the rate, the greater the money added to the original loan amount.
The Annual Percentage Rate (APR) is the most common way that business lenders quote interest. APR shows how much money you will pay for a loan over a year, including both interest and fees (such as origination fees, underwriting fees, and closing costs). The APR is the most effective way to compare rates for business loans.
Not all lenders quote their costs using an APR. Some lenders may use:
- Interest Rates: These are calculated on a monthly or weekly basis. The interest is computed as a percentage of the outstanding principal every week or month, and loan fees are not included.
- Factor Rate: Short-term lenders or merchant cash advance providers may charge a factor rate, which multiplies the capital received by the total cost to fund your business. Factor rates typically range between 1.1 and 1.5, which often translates into high APRs.
- Factoring Fees: Also known as discount rates or percentages of unpaid invoices, these fees are calculated as a percentage. They are charged in invoice factoring and generally range between 1% and 5% of the invoice value each month.
To better understand the cost of a loan, convert these interest rates to an APR. APRs make it easy to compare different products and lenders and secure the best deal possible for your business.
Does a Small Business Loan Have a Fixed Interest Rate or a Variable One?
Small business loans may have either a fixed rate or a variable rate. A fixed-rate loan has an interest rate that doesn’t change throughout the loan term, making it easier to budget.
Term loans with lump-sum payments are usually fixed-rate. This loan type is ideal for long-term business financing, such as funding a significant business expansion or purchasing real estate.
A variable-rate loan might have a lower rate initially than a fixed-rate loan. However, the rate may rise or fall, as it is tied to an underlying index that fluctuates in line with the market. Consequently, your payments will vary, making budgeting more challenging.
The interest rate on a business line of credit can also be variable. Similar to using a credit card, you can borrow money and then pay it back in installments. This loan is best for those who need cash quickly, for emergencies, or short-term working funds.
What Are the Fees for Business Loans?
Fees for business loans are not always avoidable, and they can increase the cost of borrowing. Small business lenders can charge different amounts of upfront fees, depending on factors such as the loan amount, repayment terms, credit score, and type of loan.
Your lender should explain what each fee is for when you apply for a loan.
Here are some fees that you may encounter when applying for a small business loan:
- Origination Fee: A fee charged upfront for processing a new loan.
- Underwriting Fee: A fee for evaluating and processing your loan application.
- Closing Costs are fees for servicing the loan, such as loan packaging fees, commercial real estate appraisals, or business valuations.
- SBA Loan Fee: SBA loans typically incur a guarantee fee ranging from 0% to 3.5%, depending on the loan size. The annual service fee can range between 0% and 0.55%, also depending on the loan size. The SBA updates these fees annually.
Interest Rates on Business Loans Are Affected by Several Factors
Several factors influence the interest rate for business loan. Understanding these factors and knowing how to control them will help you secure the best interest rates.
- The Lender: Small business loans from banks generally have lower rates but stricter qualifications. Online lenders may have fewer eligibility requirements but often charge more; interest rates for some online business loans range from 6% to 99%.
- Your Financial Situation: Lenders will consider traditional requirements for business loans, such as your credit score and time in business. The rate offered to you will be higher if you appear to be a high-risk borrower.
- Your Collateral: You may be able to secure a lower rate from lenders if you use business collateral, such as inventory, property, or other assets. The lender can then seize these assets if you do not repay the loan.
How to Get the Best Interest Rate on a Business Loan?
To obtain the best interest rates, you’ll need to demonstrate your business’s strengths and show that you are a low-risk borrower. Borrowers with good credit, strong finances, and extensive business experience typically have access to the lowest interest rates.
Here are some tips to help you secure the best interest rate on your business loan:
- Improve Your Credit: Work on improving your personal credit score by identifying errors in your credit report and disputing them with the credit bureaus. Pay off debts more frequently. A higher credit rating will result in a lower interest rate.
- Offer Collateral: Lower your interest rate by securing a loan with physical collateral, such as real estate or equipment. Offering collateral (especially if it is not required) can also help startups or borrowers with low credit scores obtain financing.
- Add a Cosigner: If your business is new or you have poor credit, adding a cosigner to your loan application may allow you to access more affordable options. Your cosigner should have a good credit history and financial record.
- Prepare a Detailed Business Plan: Include a business plan with your loan application to demonstrate to the lender that you are serious about your business. Your plan should illustrate that you have a viable business model, a market for your product or service, and financial projections that validate your creditworthiness.
Conclusion
Understanding the complexities of interest costs associated with business loans is essential for making sound financial decisions. By grasping how interest rates are determined and recognizing the various fees involved, you can navigate the lending landscape more effectively. Whether you opt for a fixed or variable-rate loan, being proactive in improving your credit, offering collateral, or preparing a robust business plan can significantly enhance your chances of securing favorable terms. With the right knowledge and preparation, you can ensure that your business is well-equipped to handle its financing needs, ultimately setting the stage for growth and success.
