Small business owners spend a lot of time figuring out the best way to make money for their business. The flip side of that is you also need to determine how to save money for your business.
Understanding small business loan types and how interest rates can vary is definitely a way you can save money for your business when you need to borrow — and nearly every small business needs to borrow money at some point.
That’s why we want to help small business owners with this definitive guide to small business loan interest rates.
Average Small Business Loan Interest Rates
It would be simple to understand business loan interest rates if they were like the car dealers we hear advertising everywhere — ZERO dollars down and ZERO interest for 24 months, blah blah blah.
Unfortunately, or fortunately, depending upon your perspective, small business loans come in many formats, with various interest rates for each, and those interest rates are going to be based on your type of business, your longevity in business, your business’s financial history, and even your personal creditworthiness.
The folks at Nav recently conducted a study on average annual interest rates for business loans and found a broad swath of rates for a variety of loan types:
- Traditional bank loans: 2% to 13%
- SBA (Small Business Administration) loans: 5.5% to 10.25%
- Online loans: 7% to 100%
- Merchant cash advance: 20% to 250%
- Invoice financing: 13% to 60%
As these numbers indicate, a small business owner will struggle to factor in what kind of interest rate they will be looking at without doing some in-depth research and determining what steps to take to get the best interest rate to meet the specific business’s needs.
For example, you might think going the SBA route is always the best option, but qualifying for an SBA loan requires a lot of paperwork and time, and that delay may not be what best serves your company’s current needs.
How Interest Rates Vary by Business Loan Types
As you can see from the examples, the type of business loan you seek will be the most significant factor in the interest rate you will face.
Here’s a quick overview of how interest rates are affected by the loan type:
- Business term loan: This is the traditional type of loan you’ll receive from a bank, but many online sources also offer these loans where you receive the full amount of the loan upfront and pay it back over time with monthly payments. The traditional bank loan will offer the lowest possible rate and might be the hardest to qualify for as banks don’t like to accept high risk. Online sources will carry a higher risk but with a higher interest rate.
- SBA loan: SBA loans are issued by banks but are backed by a government guarantee of repayment, so they can cover a higher risk than a traditional bank loan and carry a slightly higher interest rate. The downside is they often can take months to get through the application process and approvals.
- Merchant cash advance: These types of loans can put money into your business more quickly, but you’ll be paying higher interest rates, fees, and you’ll be paying the loan back out of your sales. Frequently, the lender recoups their money by taking a certain percentage of your credit card receipts, so you have less control over your income.
- Accounts receivable loans: These loans, also known as invoice loans, use your business’s outstanding invoices as collateral. In other words, you turn over your open invoices to the lender to pay back the loan. These typically come with higher fees and interest rates as the lender accepts your risk of not collecting on the accounts receivable.
- Equipment loans: These loans can be used only to buy equipment needed for your business because the equipment then will serve as collateral for the loan — if you don’t pay, the lender can take your equipment. Interest on these loans is more in the middle range because the lender at least has an opportunity to collect something for the equipment if your business fails to pay.
- Line of credit: A line of credit creates a pool of money you can access when you need it. These typically have a higher interest rate, but you only pay the interest on the amount you use rather than the full amount of a traditional loan. These are good solutions for businesses that have seasonal costs or high inventory periods.
How to Get a Better Small Business Loan Interest Rate
Getting a small business loan is challenging in the best of times, and it’s only gotten tougher during this year’s economic distress.
According to an Experian survey, approval rates for small business loans from all sources have dropped by more than half since the beginning of the year. The found approval rates dropped dramatically from January to April and have climbed slightly since. Their findings on the percentage of approval of small business loan applications:
- Big banks: 28.3% in January 2020, 8.9% in April 2020, 13.6% in August 2020 (the most recent one available).
- Small banks: 50.4% in January 2020, 11.8% in April 2020, 18.6% in August 2020.
- Alternative lenders: 56.1% in January 2020, 15.2% in April 2020, 23.0% in August 2020.
While those rates are expected to creep back up as the economy improves, you’ll need to do all you can to improve your chance of getting a loan and getting the best rate possible. The steps you can take to improve your interest rates:
- Have a plan: The better prepared you are to show your lender how you will spend the money and, more importantly, repay the loan, the better your chances of success.
- Improve your personal credit: You should pull your credit scores from the three major credit agencies — Experian, Equifax, and TransUnion — which you can do for free once every 12 months through the Federal Trade Commission. If you find mistakes, correct them quickly. Then improve your score by paying bills on time, reducing personal debt, not opening or closing credit cards, etc.
- Improve your business credit: Your established business also will have a credit score. You can find those scores from Dun & Bradstreet, Experian Business, and Equifax Small Business. If you have the time to improve those scores, you’ll also score better interest rates.
- Compare rates and fees: While it makes sense to look at APR for possible loans, you also want to consider additional fees. Some loans will come with annual and monthly processing fees that can substantially drive up costs. Also, a shorter-term loan with a higher interest rate could save you money over a longer-term loan with a lower interest rate, as you’ll be paying interest for many more months.
- How immediate your needs are: Short-term loans from online lenders usually come with a higher fee structure and/or interest rates, but you can receive the money within 1 to 3 business days if you have immediate needs. If you have an opportunity to expand, will it cost your business more to lose the opportunity or pay a little higher interest?
- Consider a leveraged loan: Do you have the equipment, real estate, or other items of value you can put up as collateral against the loan? Most lenders will give you a better rate if they have a better guarantee of recovering their money, which collateral makes possible.
