Small business loan interest rates are complicated for the unpracticed, but with a little research, you can quickly gain a solid understanding of how they work.
From there, you’ll be well-equipped to decide which small business financing is most beneficial for your situation.
Let’s dive right in.
First, it is important to understand not all loans are financed in the same way.
Learning the appropriate terminology will make it easier to determine the type and how much it will truly cost over the lifetime of the loan.
If you are familiar with interest rates in your personal life, it will be comforting to realize there are many similarities in how personal and business loan interest rates are determined.
Finally, there are many different types of loans available.
There are several loan types which can be used for similar purposes, but it is crucial to weigh the pros and cons of each type before getting a business loan.
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APR vs. Interest Rates for Small Business Loans
The first thing people look for when assessing which type of funding to secure are the business loan interest rates for each product.
This number indicates the amount of interest which will be paid annually based on the total amount of the loan.
Lower business loan interest rates mean it should cost less to borrow the money and result in lower monthly payments but this isn’t always the case.
The average percentage rate (APR) paints a complete picture of the true cost of the loan to the company.
It incorporates the business loan interest rates plus any associated processing or monthly fees.
It is important to factor in any ongoing fees which will be included each month as this can dramatically increase the total monthly payment and the total amount one will need to repay.
Learn more about APR vs. Interest Rates
What Affects Business Loan Interest Rates?
There are numerous considerations that go into determining small business loan interest rates, not the least of which is the federal funds rate at the time of your loan request.
Beyond that, lenders will evaluate both your personal credit score and your business credit score during the request process.
Depending on the lender, there may be a minimum acceptable credit score.
The lender will also look to ensure you have met previous financial obligations in a timely manner.
Not only will these factors be used to determine if a business will qualify for a loan, it will also help determine the business loan interest rates offered if the loan is received.
Better terms and interest rates are sometimes available to those individuals and businesses with higher credit scores.
Other things that can influence small business loan interest rates are the relationship between the lender and the borrower and the amount of the loan.
If the borrower has done business with the lender before and has a good personal history with them it may be easier to get lower rates.
Because the cost of underwriting a loan is the same for the lender regardless of the size or term of the loan, they may charge more in fees or higher business loan interest rates than for those for loans which are more substantial.
Business Loan Interest Rates Vary By Types of Financing
Small business loans come in all varieties, but they can be grouped into two broad categories:
Typically either an installment loan or a line of credit.
An installment loan is similar to a mortgage or car payment in that it allows the borrower to obtain a predefined amount of money for a specific purpose and make monthly payments to repay the principle, interest, and associated fees.
Once the balance is brought down to zero the debt is repaid and the financial arrangement with the lending institution is completed.
Lines of credit, however, function a little differently.
Business Line of Credit
A business line of credit often has loan terms between six months and five years for between $10,000 and $1 million.
The average interest rates for a business line of credit is between about 7 and 25 percent.
Because of the perceived stability of the arrangement, business loan interest rates tend to be lower with installment loans.
They offer the lender more security, which may translate into savings for the consumer.
However, obtaining an open line of credit provides more flexibility for the borrower.
Business Credit Cards
Business credit cards offer companies a revolving line of credit of up to about $50,000 with an APR of between 0% and 24.99% and some cards have generous bonuses and rewards.
They can help businesses establish independent credit ratings and make it easier to keep business and personal accounts separate.
A business line of credit is an ongoing relationship between a borrower and lender which functions more like a credit card.
The lender evaluates the business and sets a maximum amount of money which can be borrowed at a given time.
The borrower can make withdrawals as needed, and each month makes payments on the total balance.
This is typically a percentage of the total amount borrowed, but there may be a minimum amount due on any balance.
Even when the balance of the account reaches zero, the account does not close.
The borrower continues to have access to the funds but has no further payments until more money is withdrawn.
Working Capital Loans
Working capital loans are used when a business needs funds to continue operations.
It isn’t necessarily for new purchases that will help the business grow.
Some of the reasons a working capital loan might be necessary include:
- funding payroll
- creating a new marketing strategy
- remodeling or repair
- equipment purchases
- paying taxes
- financial emergencies
- or making it through a slow season or economic downturn.
Short Term Business Loans
Short term business loans have terms between three and eighteen months for amounts between about $2,500 and $250,000.
Short term business loan interest rates tend to be 14 percent and higher.
These are a good all-purpose loan for when a company needs extra capital quickly and only for a short period like taking advantage of an amazing and unexpected growth opportunity.
Term loans have terms of between one and five years and are available in amounts between $25,000 and $500,000.
The interest rate for these loans is between about 7 and 30 percent.
These are great for companies that need quick access to working capital that they can repay at a slower rate.
Business acquisition loans are obtained in order to purchase someone else’s business, buying out an existing business partner, or finance a franchise.
In some instances, the only thing the company which is being purchased has is equipment.
Equipment financing is a loan for a very specific purpose.
It can only be used to finance industry essential equipment, but any type of industry is eligible.
This could cover construction machinery, drilling equipment, or medical equipment.
The terms and loan amount depend on the estimated life and cost of the equipment and typically have business loan interest rates of between 8 and 30 percent.
It is possible to finance the total cost of the equipment but a down payment may be required.
A Small Business Administration (SBA) loan is backed by the government.
There are several loan programs available by the SBA that distribute billions of dollars annually.
Funds from SBA loans can be obtained for virtually any business expenses, including the purchase of equipment or inventory, real estate, working capital, business acquisition, and refinancing business debt.
Loan amounts are available between $5,000 and $5 million with loan terms between 5 and 25 years and business loan interest rates between 6 and 13%.
What if you’re just getting started?
One of the problems with opening a small business is that the business itself does not have any credit of its own at first.
This can make it difficult for entrepreneurs and small business owners to find the funds to grow, and it’s tough to know where to even begin.
Personal loans for business purposes are a great option for business owners with good personal credit but no business credit history.
Loans are available for amounts of up to $100,000 with terms up to 7 years and APR rates between 4 and 36%.
Because the loan is based on personal credit scores it does not require information about the business in most cases.
However, since it is a personal loan it will ultimately help or hurt your personal credit instead of limiting the risk to the business.
A startup business loan is another good option for those who are just getting started.
You will still be leveraging your personal credit score but it will move the risk over to the business.
You will typically need a business plan and detailed information about how well the business is doing or strong projections for the company once it launches.
Loan amounts can reach up to $150,000 with loan terms between six months and four years.
Business loan interest rates for this type of product range between about 7.9 and 19.9%.
Factor Rate Loans
Business loan interest rates aren’t the only way to figure the costs of loans.
In fact, some forms of financing aren’t based on interest rates at all, as is the case with MCAs and invoice financing.
Merchant Cash Advance
A merchant cash advance is a factor rate loan product (and one that not all businesses are aware of.)
With this type of loan, the lender is purchasing a piece of the future revenues of the business.
The borrower receives a lump sum cash advance and then makes payments that vary based on daily revenue.
This could occur daily, weekly, or at another agreed upon timeframe.
The amount paid will be based on the credit card sales for the defined period.
The loan amount can be from between $2,500 and $250,000 at a factor rate of between 1.14 and 1.18.
Invoice financing is another that uses factor rates instead of normal business loan interest rates.
With this type of loan, a business is selling unpaid invoices to the lender in exchange for an upfront cash payment for a portion of the invoice total.
The loan amount can be for between 50 and 90% of the loan and have a factor rates that begin at about 3 percent plus a percentage for each week the invoice is outstanding.
Once the invoice has been paid by the customer the borrower receives the remaining 10 to 50% of the money from their paid invoice minus the factor fee.
A factor rate is expressed in a decimal figure and is based on the type of industry, stability of sales, length of time in business, and average monthly sales from credit card purchases.
These financing tools tend to be the among the most expensive, so it’s important to determine the total cost before making the decision.
The loan itself will usually be paid back in more frequent and smaller installments than other types.
Business Loan Interest Rates & You – Putting It All Together
It may be apparent that many of these types of business loans can fit into multiple categories.
When getting a business loan, it is important to consider all options thoroughly.
The ultimate purpose of securing a loan is to obtain the necessary funds to accomplish your business goals.
Let’s say a company has been in business for five years and is ready to offer a greater number of products or services but doesn’t have the capital necessary to implement the plan.
If the growth involves purchasing new equipment for a construction business, they could choose between an equipment financing loan, term loan, or line of credit.
A business emergency that requires a quick fix also has many possible solutions:
You could request a business credit card or a personal line of credit to keep a small problem from getting out of hand.
But you could also request a short-term business loan, merchant cash advance, or invoice financing.
There is no universally correct choice in the process of business loan selection.
What works for one company may not be the best fit for another, and not all lenders are willing to work with borrowers in the same way.