If you are a small business owner looking to expand your business, purchase new equipment, or cover unexpected expenses, taking out a business loan may be the solution. However, before you sign on the dotted line, it is important to understand the interest rate on the loan.
The interest rate is the amount of money you will pay the lender in exchange for borrowing the funds. It is a crucial component of any business loan and can significantly impact your business’s financial health. In this guide, we will discuss what a good business loan interest rate is, the average interest rate on the most popular business loans, and where to find a reasonable interest rate on your business loan.
By understanding the factors that influence interest rates and comparing offers from different lenders, you can secure the best possible loan for your business.
How Do Interest Rates on Business Loans Work?
Interest rates are an essential component of any business loan. They affect the cost of borrowing and can significantly impact your business’s financial health. Therefore, it is crucial to understand how interest rates on business loans work.
The interest rate on a business loan is primarily determined by the lender’s assessment of the borrower’s creditworthiness and the level of risk involved in lending to the business. The lender will look at various factors, such as the borrower’s credit score, financial statements, business plan, and collateral, to determine the interest rate.
If the lender considers the borrower to be a low-risk borrower, they will offer a lower interest rate. Conversely, if the borrower is deemed high risk, the lender may charge a higher interest rate to compensate for the increased risk.
Another factor that affects the interest rate on a business loan is the type of loan. For example, secured loans, which require collateral, typically have lower interest rates than unsecured loans that do not require collateral.
Furthermore, the loan term also affects the interest rate. Short-term loans usually have higher interest rates than long-term loans because the lender is taking on more risk by lending money for a shorter period.
It is also important to note that interest rates can be fixed or variable. A fixed interest rate means that the interest rate remains the same throughout the loan term. This means that the borrower’s monthly payments will remain the same, making it easier to budget and plan for the future.
On the other hand, a variable interest rate means that the interest rate can fluctuate over the loan term. This means that the borrower’s monthly payments can change, making it harder to budget and plan for the future. However, variable interest rates can be beneficial if interest rates fall, as the borrower will pay less interest over the loan term.
In addition to the interest rate, lenders may also charge fees, such as application fees, origination fees, and prepayment penalties. These fees can add up quickly and increase the overall cost of the loan, so it is essential to understand the fees associated with the loan before signing the loan agreement.
It is also important to compare interest rates and fees from different lenders to ensure that you are getting the best deal. Shopping around for the best interest rate can save you thousands of dollars over the loan term.
What is a Good Business Loan Interest Rate?
Several factors go into determining the business loan interest you’ll pay. Much boils down to your qualifications. For example, if your personal or business credit score is poor or your business is young, you may end up paying more in interest.
Ideally, a good business loan interest ranges from 2% to 13% for traditional banks and can go as high as 100% for online lenders.
However, it is important to note that the interest rate alone does not determine whether a loan is a good deal. Other factors, such as the loan term, fees, and repayment schedule, also play a significant role in determining the overall cost of the loan.
When considering what a good business loan interest rate is, it is important to look at the loan type. For example, SBA loans typically have lower interest rates than traditional bank loans, but they may have more stringent eligibility requirements and longer processing times.
Another factor to consider is the loan term. Short-term loans usually have higher interest rates than long-term loans, but they may be more suitable for businesses that need funds quickly and can repay the loan in a shorter period. Long-term loans, on the other hand, have lower interest rates but may require collateral and a more extensive application process.
It is also important to consider the lender’s reputation and customer service when evaluating a loan offer. A lender with a good reputation and excellent customer service can make the loan process smoother and more transparent, which can save you time and money in the long run.
When comparing loan offers, it is essential to read the fine print carefully and understand all the terms and conditions of the loan. Pay attention to any fees, such as origination fees, application fees, and prepayment penalties, which can add up quickly and increase the overall cost of the loan.
Average Interest Rate on Most Common Types of Business Loans
As mentioned before, the average business loan interest rate varies depending on the kind of loan you’re looking to apply for. However, here’s what you can expect to pay as interest for popular types of business loans.
Traditional Bank Business Loans: 2% to 13% APR
Traditional bank loans are the most attractive financing option for small businesses because of their low-interest rates. However, getting approved for these loans is difficult due to their strict qualifications. These lenders typically approve borrowers with strong credit, collateral and at least two years in business.
In addition to the strict qualifications, traditional bank loans may also have longer processing times, which can be a disadvantage for businesses that need funds quickly. However, these loans may be more suitable for businesses with a stable financial history and a long-term plan for growth. Traditional bank loans also offer more flexibility in terms of loan amounts and repayment schedules, which can be beneficial for businesses with specific financing needs. Still, you may be subject to loan fees.
SBA Loans: 5.5% to 11.5% APR
SBA loans are government-backed loans offered through approved participating lenders, such as traditional banks and credit unions. Since these loans are partially guaranteed, they have lower interest rates, larger loan amounts, and longer repayment terms. As a result, SBA loans are the best fit for small businesses that may not otherwise qualify for traditional loans.
SBA loans also have more flexible eligibility requirements than traditional bank loans, making them more accessible to a wider range of businesses. However, the application process for SBA loans can be more time-consuming and require more documentation than traditional bank loans. Additionally, SBA loans may have higher fees than traditional bank loans, such as guarantee fees and servicing fees.
Small Business Term Loans: 7%+ APR
Small business term loans give you access to a lump sum of money, repayable within a specified period of time. The repayment period for term loans starts from 3 months to 10 years, and borrowers can use it for nearly every purpose.
Small business term loans are a popular financing option for businesses that need funds for specific projects or investments. These fixed-rate loans come with predictable repayment schedules, making them easier to budget and plan for. However, small business term loans may have higher interest rates than traditional bank loans and may require collateral to secure the loan. Additionally, the application process for small business term loans can be more rigorous than other types of loans, requiring extensive documentation and financial statements.
Working Capital Loans: 16%+ APR
Small business owners borrow this type of short-term loan to finance day-to-day operations, such as covering payroll, rent, and debt payments. The interest rate on working capital loans may start at 16%, depending on the lender and the amount you borrow.
Working capital loans are a useful financing option for businesses that need to cover short-term expenses or unexpected cash flow gaps. However, these loans typically have higher interest rates than traditional bank loans and may require frequent repayments and come with origination fees. Working capital loans may also have lower loan amounts than other types of loans, making them less suitable for larger investments or long-term projects.
Business Line of Credit: 7% to 25% APR
A business line of credit allows you to borrow up to a certain limit and pay interest on what you draw. It works like a credit card because once you repay the borrowed amount in full, you can borrow again. A business line of credit is ideal for businesses that require access to funds on a needed basis.
These loans typically have variable interest rates and may require collateral to secure the loan. Additionally, business lines of credit may have fees, such as annual fees or draw fees, which can increase the overall cost of the loan.
Merchant Cash Advance: starting at 20%
A merchant cash advance gives you access to a lump sum of money upfront, repayable with a percentage of future business sales. This business financing option is a perfect option for businesses that accept debit and credit card payments from customers. However, MCAs tend to be very expensive, and APR can start upwards of 20%.
Merchant cash advances are a high-cost financing option that should be used with caution. While these loans can provide businesses with quick access to funds, they typically have high interest rates and fees. Additionally, the repayment structure of merchant cash advances, which requires a percentage of future sales, can be unpredictable and may put a strain on a business’s cash flow.
Invoice Factoring: 13% to 60% APR
Invoice factoring is a short-term business financing where you sell some of your outstanding invoices at a discount to a third party, typically an invoice factoring company, in exchange for cash upfront. The factoring company is responsible for collecting the invoices directly from your customers. You can expect to pay anywhere between 13% to 60% interest for invoice factoring.
Invoice factoring can be a useful financing option for businesses that need to improve their cash flow and reduce their accounts receivable. By selling their outstanding invoices to a factoring company, businesses can receive cash upfront and avoid the wait for customers to pay their invoices. However, invoice factoring can be more expensive than other types of financing, with interest rates ranging from 13% to 60%. Additionally, businesses must have a steady stream of invoices to factor. They may need to meet certain eligibility requirements, such as a minimum credit score or a certain amount of monthly revenue.
Equipment Financing: 4% to 40% APR
This is a loan used to purchase or lease business-related equipment. You can use the funds for almost any equipment purchase, from IT to heavy machinery and vehicles. Equipment financing attracts an APR ranging from 4% to 40%.
Equipment financing can be a useful financing option for businesses that need to purchase or lease equipment to support their operations. By using equipment financing, businesses can access the necessary funds to acquire the equipment they need without having to pay for it upfront. However, equipment financing can have higher interest rates than other types of financing, with APRs ranging from 4% to 40%. Additionally, businesses may need to provide collateral to secure the loan and may face penalties for early repayment.
What Factors Affect Interest Rates on Business Loans?
Several factors influence interest rates on business loans, with the most common ones being:
Personal and Business Credit
Your personal and business credit score is one of the most popular aspects lenders look at when evaluating your eligibility for a loan. Credit history affects not only the financing options available to you but also the interest rate. Where your credit score stands currently determines what interest rate you’ll qualify for.
Loan Type
The type of loan you’re looking to apply for also influences the interest rate you get. Different types of loans offer different interest rates. For example, SBA loans have rates ranging from 8.5% to 11% because they’re backed by the U.S. Small Business Administration. Loans from alternative lenders may come with high rates.
Collateral
A business that provides collateral tends to get better rates than those that don’t because it reduces the lender’s risk. Collateral can be any personal or business asset the lender can seize and sell to recoup the loan balance in case you default.
Time in Business
Your small business loan rate depends on how long you’ve been operating. This is because lenders look at the time in business to evaluate their lending risks. Most times, lenders are hesitant to loan to companies that have been in business for less than two years because they consider them risky. For this reason, they charge higher rates for business loans.
Repayment Terms
Loan terms impact average business loan rates. Choosing a shorter loan term attracts higher interest rates, while longer repayment terms come with lower interest rates. Although loans with longer terms may sound like a good deal, they often cost more over the life of the loan.
Other Costs and Fees
Lenders may also charge additional fees that may impact the business loan interest rate you pay. This may include origination fees, prepayment penalties, and late payment fees. Therefore, it’s a good idea to understand the true cost of your loan beforehand.
Your Relationship with Your Lender
Lenders may give lower rates to borrowers they have worked with previously. If you made on-time payments for your last loan, you might easily get approved for a second loan and negotiate a better business loan rate with your lender.
