Small business loan interest rates can vary tremendously – but what are they based on?
Some businesses will get financing with single digit interest rates while other types of businesses may pay as much as 100+% interest for loans. The interest rate your business pays will depend on many things depending on the business risk and credit profile and a host of other factors. Have you ever wondered what factors can influence a small business loan? This article addresses some of the levers at play when lenders set small business interest rates.
Your own personal credit score matters more than you might think when you are applying for a business loan
If you’ve ever taken out a personal loan such as a car loan or student loan, you know that your interest rate will depend on your credit. For many small business loans, the bank may turn to you as a proxy for your business and may want to know how credit worthy you are in addition to how credit worthy the business is. A small business owner with poor personal credit could end up paying higher interest on a business loan or could even be denied. In addition, you may be asked to personally guarantee a small business loan.
Different types of loans can command different interest rates
Longer term loans through mainstream financial institutions and the Small Business Association (SBA) will have the lowest rates. You can expect bank loans to be between 5-15%, as long as your business is credit worthy and meets the lender’s eligibility standards.
As a general rule, alternative lenders and shorter term loans will have higher rates. Some alternative small business loans can offer rates that are quite high, with rates from 50-100+% APR.
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National interest rates will impact the rates of business funding
National interest rates set by the Federal Reserve are one of the most important forces in determining the interest rate you will get on a loan for your business. Lenders often base their interest rates off of national interest rates. If national interest rates are high, interest rates on nearly every type of loan will rise, and the flip side is true as well.
Your company history will factor into your interest rate
It can be challenging to get a loan if your business is very new or a start-up. Banks often view new businesses without a credit history as riskier than businesses that are mores established. If you have a newer business, you may need to search harder for a lender that will work with you and you may need to pay a higher interest rate in order to compensate them for the perceived risk of working with you. Be sure to bring your business plan to show the lender how your business works to reassure them that they will be repaid. And just like individuals, established businesses have credit scores too. If you have a more established business, you can check its credit profile with the 3 main business credit bureaus: Dun & Bradstreet, Expertian Business, and Equifax Small Business.
Strong company financials can help you get a good rate on a loan
All lenders will look to see how your business is doing financially in order to predict your repayment ability. They may request your business financial statements, balance sheet, and tax returns, so it’s a good idea to keep them handy and up to date, whether you use automated software or a bookkeeper. It should come as no surprise that businesses who are perceived to be doing well, who are stable, and who have guaranteed or reliable sources of revenue are more likely to be underwritten by lenders and may command a lower interest rate. ‘
Banks may ask for collateral to secure a small business loan.
You may be asked to provide collateral when securing a small business loan and lenders may charge higher rates for lower or no collateral loans. Collateral can include things like your business’ equipment, real estate owned by your business, deposits that you promise to keep on hand, inventory, accounts receivable or outstanding invoices, securities, or your own personal home equity. Typically, lenders will require more liquid assets as collateral on a shorter term loan and may accept more illiquid assets (like real estate) for longer term loans. This collateral can help the lender feel secure in extending your business credit because they know there are assets they can take if you default. According to Dale Van Eckhout, the Senior Area Manager of the Bismark Small Business Association office, “The borrower must put their assets (collateral) at risk or in other words have “skin in the game” in order to obtain the needed financing for their business. “ The higher the amount of money, the more likely you are to be required to produce collateral to back the loan. In many cases, your lender will send an appraiser to determine the value of the collateral. The lender may then “discount” the value of the collateral to a lesser amount, since they may have to sell it in haste if you default on the loan.
If you are struggling to get a small business loan through a traditional bank, there are alternatives.
Merchant cash advances are an option, but can be expensive
Your payment processor or an alternative lender may offer you something called a “merchant cash advance” in which they are giving you cash now in exchange for a portion of your incoming sales. These products can be a good way for your business to get funds in a quick and less cumbersome way. They can be a good fit for businesses or individuals with bad credit or who have trouble qualifying for traditional small business financing. Shawn Cannon of OWNit Brands says that his small business struggles to get traditional loans. “We have turned to use factoring and cash advances from our merchant payment processors. That’s helped us to free up our cash flow and we repay them out of a percentage of our sales. We’ve done this with Stripe, Paypal, Shopify, Amazon, and Payability.”
Small business credit cards can serve as a flexible form of financing
You may be able to get a small business credit card from your bank and it can be a way to make ongoing or major purchases for your business. It may even offer perks like cash back or points that you find appealing. Similarly to a small business loan, the credit card issuer may insist on checking your personal credit before issuing you a small business credit card. You may find that the interest rates for carrying a balance on a business credit card are high, however. In some cases, a business credit card might have a promotional 0% or low APR, which can be a good way to increase your business’ purchasing power on a short term basis. A similar product is a small business line of credit, which is a cross between a business loan and a business credit card. Learn more about small business lines of credit here.
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