October 8, 2018 | Last Updated on: June 27, 2023
While borrowing money is necessary for many small businesses, savvy owners are always looking for ways to reduce the interest rates for those business loans. After all, depending on the loan amount, the type of loan, and the health of the business, loan payment can quickly spiral out of control, affecting every aspect of the company.
So how can business owners go about reducing those interest rates? Here are a few tips.
Before you consider the specific ways to reduce interest rates for your business loans, you should consider interest rates on a larger scale. What are interest rates?
In essence, the interest rate on a business loan is the lender’s way of protecting itself from the possibility of a business’s decline or failure. So what are those lenders looking for? What are the red flags that would lead a lender to assign a higher interest rate? Once you’re able to recognize those issues, fixing any of them could lead to a reduction in interest because you’re actively making your business a safer bet.
One of the first and most important metrics for any lender is the business owner’s credit score. So when you’re looking to secure the lowest possible interest rate, it pays dividends to start with improving your personal score.
You’re wise to keep your personal finances separate from your business finances. But that doesn’t mean that your good or bad credit score isn’t a helpful indicator of your history and likelihood of repaying a debt. The first step you should take in separating your personal finances from your business finances is opening a separate bank account and credit card specially for your business operations.
Now, if you’re looking at reducing a likely interest rate before you’ve acquired the loan, this is an important strategy for showing the lender you’re a qualified borrower. But achieving a good credit score can also bend the situation your way if you ever decide to secure another small business loan.
If is important to fully understand your credit score and how it will impact numerous factors relating to the future of your business. Check out this helpful and informative guide from Biz2Credit on understanding business credit scores.
Particularly before you’ve acquired a loan, it’s important to have done a significant amount of leg work. That work pays off with a reduced interest rate.
There are countless different ways to borrow money for your business. There are loans it’s tough to qualify for, loans that take a long time, loans that you pay back daily, and every type in between. And one way to make sure you’re paying the lowest possible interest rate is to complete the research necessary to know that you’ve borrowed from the best possible lender.
For some businesses, that could very well be a high-interest, fast-acting lender. And that’s fine if that’s the best situation for you.
But if your business could be eligible for a long-term, low-interest loan, why go with the shorter-term loan you’ll pay many thousands more in interest on? Doing your homework ensures you’re looking in the right place for your lender, leading to the best interest rate for your situation.
There are two ways lenders calculate interest: simple interest and compound interest. In simple interest, a lender will require repayment in a certain amount of time at an amount somewhere above the original amount owed.
If you have a simple interest rate of 20% on a loan of $100,000, you will repay $120,000 over the life of the loan.
Compound interest is different. And it can be a boon to your business if you’re willing to put in the work to pay the loan quickly. Compound interest is calculated at certain set intervals, and the interest is calculated based on the remaining balance of the original loan in addition to previously accrued interest.
If you pay these loans more quickly, the interest will be lessened. So if your loan is compounded weekly, monthly, annually, or daily, it is wise to pay it back as soon as possible. The longer the principle remains high, the more you’ll pay in interest.
But even some loans with simple interest rates can benefit from being paid early. Many loans have a particular date at which the interest rate increases if there’s a remaining balance. That bump in interest rate can cost thousands, so make sure you’re paying as soon as possible.
There are plenty of situations where refinancing your business’s debts is the best way to reduce the interest rate on a business loan. And refinancing might also make your business simpler to run.
If you acquired multiple loans at high-interest rates at the beginning of your business and your finances have improved, refinancing could be an option. You could consolidate the outstanding debt into a single loan with a reduced interest rate based on the improvement of your company’s financial health.
Or if you started your business with a short-term loan at a high interest rate, you could use your improved circumstances to secure a longer-term loan to cover the original. That way, your success buys you more time to pay off less interest. The original lender gets paid, you pay a lower interest rate, and the new lender is in business with a partner they can be confident will pay them back in full.
You could even use this opportunity to change types of loans. If you’re qualified for an SBA loan during refinancing but weren’t at the beginning, that’s one situation where you might be best served by applying for an SBA loan.
Whether you’re looking to reduce rates at the beginning of a loan, during a refinancing, or anywhere in between, you’ll likely be meeting or otherwise speaking with a representative of the lender, so it’s important to remember the human element.
The small business lender is looking at you as a possible bet. What are the chances this person’s business will repay this loan?
So when you meet with lenders at your financial institution, make sure you’re completely and utterly prepared. That goes for appearance of course. Treat these meetings like job interviews.
But preparation also means putting time and effort into a thorough business plan. It means practicing your speech or presentation, knowing what questions will come up, making sure you’ve got the proper and necessary documents and records on hand, and being ready to answer questions about those, too. Have a smart business plan and be ready to explain the future of your company.
All these tips boil down to the same idea: prove to the lender that you’re trustworthy.
The most important thing you can do is prove to the lenders that there’s no chance you won’t repay a loan. Once you’ve proven you’re not at risk for failing to pay, they’ll be much more likely to reduce your business loan’s interest rate – or start you off much lower from the beginning.
