May 18, 2022 | Last Updated on: February 2, 2023
How should business owners approach interest rates on their business loans? We’ve collected the most important information about business loan interest rates here in this definitive guide.
In today’s competitive environment, it is common for small business owners to need financing quickly. But in the rush to acquire the funds they need, small business owners may not fully grasp the impact of the business loan interest rates that come with the loan. If you understand the interest rates that your business qualifies to receive, then you can more easily compare loan options, understand when your business might need to refinance existing debt or plan for the next financial chapter for your company.
The typical business loan interest rates that a small business owner may be charged depends on a wide variety of factors, and they can cause rates to vary wildly. Among the factors to consider are the type of small business lender providing the loan and the financial health of the small business itself. Knowing how loan interest rates for business loans – and also any fees associated with those loans – work can give small business owners an edge when it comes to affordable financing eligibility.
Under normal circumstances, small business owners can expect average annual percentage rates (APRs) of between three percent and seven percent for traditional banks. Online – or alternative –lenders traditionally skew much higher, ranging from 11 percent to 44 percent or more.
How can small business owners determine what is a good rate for a commercial loan? And what range of rates can they expect to see today and in the near future?
The first step in this process is understanding what the average rate on a business loan is. Of course, this rate depends on the type of loan and lender.
As a result, having a clear picture of exactly what type of loan and loan amount they need can help a small business understand what type of interest rate it can expect to pay. The credit score of a small business also is a decisive factor in determining what the interest rate on a loan will be.
This average interest rate also varies by the type of loan. As such, it can range from two percent to more than 100 percent. The annual interest rate (AIR) on a traditional bank loan, for instance, can fall anywhere between two percent and 13 percent. In general, banks and credit unions tend to offer lowest interest rates on small business loans. But the drawbacks of doing business with these types of lenders is that underwriting requirements are much stricter and approval can take a while.
Interest rates, of course, can rise and fall over time. What is a reasonable interest rate for a business loan as of today? Current business loan rates from banks vary from 2.54 percent to 7.02 percent, according to recent data from the Federal Reserve.
Loan programs from the Small Business Administration (SBA) are provided through traditional banks, but at lower interest rates. SBA loan interest rates for 2022 range from 3.25 percent to eight percent. SBA loans are generally made through banks, but the loans are partially guaranteed by the SBA. This creates less risk and, as a result, lower interest rates.
Economic Injury Disaster Loans are an example of loans made by the SBA. The popular SBA 7(a) or 504 loans – along with the Paycheck Protection Program loans — are examples of loans guaranteed by the SBA. All of these loans offer rates that are very competitive, but these rates vary depending on the type of SBA loan. SBA lenders may also negotiate rates within certain defined parameters.
Since SBA loans tend to be issued by traditional banks, they also tend to have strict underwriting requirements and slower approval times.
Online lendersoffer faster approval and funding than traditional banks, but this quick turnaround comes at a price. Interest rates for loans provided through online lenders can vary from seven percent to 100 percent.
Merchant cash advances come with an even heftier price tag, as interest rates on this form of financing can fall between 20 percent and 250 percent.
Invoice financing can be another expensive proposition, with rates between 13 percent and 60 percent.
Among the decisions that business financing involves is the choice between fixed interest rates and variable interest rates. A fixed interest rate means that the rate will remain the same throughout the duration of the loan. Variable rates, on the other hand, can change and may rise or drop. Loans with variable interest rates may be linked to the prime rates or other rates that are significant within the economy.
Variable rates can be misleading since they are often lower initially than fixed rates but can easily rise. This, in turn, can saddle the small business owner with an expected higher monthly payment. This unpredictability of variable rates can make it tough for business owners to plan and budget for the future.
Fixed rates also have a potential downside. If, for instance, a business owner received a fixed rate at a higher interest rate, they can be locked into the rate even if rates were to drop. In such cases, business owners have the option of refinancing at the lower rate.
The plethora of lenders in the market today gives small business owners a number of financing options, yet there isn’t one single location to shop rates from all lenders at any given point in time. This makes it difficult to see how all business loan interest rates compare.
Still, small business owners need to be able to sort through the annual percentage rates (APRs), loans and other terms that combine to result in different monthly repayment terms depending on the loan. It’s natural for small business owners to ask, “What is the lowest business loan interest rate,” or “Which bank gives the cheapest business loan rates?” But, with all the variables involved in determining an interest rate, there is no set answer to this question.
In the current environment, interest rates in general are very low. Locking in a low fixed rate – such as two percent, for example — for the duration of the loan may be the most cost-effective solution for a small business owner.
To be able to better sort through everything that goes into creating a monthly payment, small business owners can use a business loan interest ratescalculator to estimate their monthly payments and make more informed business decisions.
One of the key components of interest rates is the prime rate. The prime rate is the interest rate that banks charge their most credit-worthy clients. The prime rate itself is determined by the federal funds rate, which is the interest rate that banks charge each other. The SBA — and all lenders — use the prime rate as a floor when setting interest rates.
Other factors such as the personal credit scores of the business owners, the amount of time the business has been operating, the financial strength of the business, the loan repayment term and the accessibility of the loan play a role in determining interest rates.
Long-term loans tend to have lower interest rates, since the funds are being borrowed for a longer period of time. Conversely, short-term loans have higher interest rates. But, despite the higher rates, business owners pay less interest overall with a short-term loan.
Accessibility of the loan refers to the length of time it takes the business loan to be approved. Traditional banks tend to require a great deal of paperwork, and it can take a month or longer for the loan to be processed. But, should the loan be approved, the intense scrutiny will result in a more favorable interest rate.
Still, for small business owners who need funds quickly, a bank loan is not a viable option. Alternative lenders offer business loans that are easy to apply for and quick to approve. Funding can arrive in a matter of days, rather than weeks. But this ease of doing business will result in a significantly higher interest rate.
Whether it be traditional banks, credit unions or online lenders, the following criteria are typically required during the loan application process:
Other variables such as the amount of the loan, collateral required, and the industry in which the business seeking the loan operates can affect the interest rate that will be charged. While many factors that influence interest rates – and even approval — for small business loans are out of the control of small business owners, there are several ways to reduce the credit risk of the business. By reducing this risk, it is possible to qualify for a lower rate.
It is possible that a small business owner may need to provide a personal guarantee to qualify for a small business loan. That’s why commercial lenders look at the personal credit score of a small business owner in addition to the credit history of the business. The personal guarantee ensures that the loan will be repaid should the business not be able to fulfill its loan obligation.
How can small business owners improve their credit score? Small business owners should thus check their personal and business credit reports for places they can improve their scores. Incurring less debt, paying off credit card balances and reconciling late payments are a few ways business owners can improve their credit scores.
When applying for a business loan, small business owners might not look beyond monthly payments and overall repayment terms. By doing so, they may not grasp the full cost of the loan. For instance, some business loans charge higher interest rates whether or not the business has a good credit score and positive cash flow.
Short-term loans, invoice factoring and merchant cash advances are all examples of financing options that charge higher rates than traditional loans. While these options may make sense in some cases, small business owners need to be confident they are getting the financing that is the best fit for their operation. This will help ensure that their monthly payment is as low as it can be.
Fees are another aspect of the loan process that raise a monthly payment that requires scrutiny. While fees are not included in your interest rate, they factor into the calculation of the annual percentage rate (APR) of the loan and can increase its overall cost.
The type and amount of fees can vary from lender to lender, and sometimes fees are unavoidable. Application fees, origination fees, closing fees, processing fees, service fees and prepayment penalties are all examples of the types of fees that can be tacked onto a loan, and that can increase a monthly payment. Below is brief explanation of fees that are typically charged:
Application fees are charged for processing loan applications and to pay for the credit check. They are typically not refundable, even if a loan application is denied.
Origination fees are a basically payment for processing a loan application. The amount is normally one to two percent of the loan. It’s not unusual for this amount to be deducted from the face amount of the loan, slightly lowering the amount of funding the business owner receives.
Closing fees is a term that includes all fees charged during the loan process, plus others that may arise. For instance, it’s common for appraisal fees to be added to a real estate loan.
Processing fees are fees for underwriting and administration. They can range up to five percent.
Prepayment fees are a penalty that can be charged when a business loan is paid off prematurely. They can be roughly three to five percent of the loan’s amount of principal. Their purpose is to compensate the lending institution for lost interest on the loan.
Collateral A loan that is secured with collateral generally charges a lower interest rate than an unsecured loan. Collateral can take the form of assets from a business, such as equipment or real estate. In fact, equipment financing is a popular form of business financing. The downside of using collateral, of course, is that the asset used can be lost should the business owner default on the loan.
Now that you have a better understanding of the many variables that can affect your interest rate on a loan, you can make a more informed decision the next time you apply for a small business loan. It is important to approach this process holistically and seek areas of improvement on your financial health to secure the best loan option possible. You can use specialized tools to help you manage your business credit and qualify for the best interest rates on your next funding request.
March 20, 2023
