Are you hesitant about getting a business loan due to high-interest rates?
If you’re a new business owner or entrepreneur and you are looking to take out a business loan,
so you can scale your business then this might be the most important article you’ll read today.
Let me explain why:
Business loans are crucial tools that provide business owners with the necessary funding to expand or grow their companies.
However, these loans are, of course, not free. Interest rates are the cost of acquiring the loan.
Ideally, you’d want interest rates to be lower.
However, key factors, including credit scores, cash flow, collateral, and more, can impact the interest rate.
Lenders will evaluate your creditworthiness, financial history, and more to break down the proper loan, interest rates, and terms for you.
With over two decades of experience as a financial coach and banking expert, you’ll also learn a few external factors that affect these interest rates below.
Without further ado, here are eight key factors that impact business loan interest rates:
Factors Impacting Business Loan Interest Rates
Business loan interest rates are the cost of borrowing money for the loan.
The interest rate is a percentage of the loan amount and is usually charged monthly or annually, depending on the agreement.
Interest rates depend on various factors, such as the borrower’s credit score, financial history, loan amount, and collateral.
Generally, interest rates for business loans start at around 20% or higher.
Business Age and Financial History
The business’s age and financial history influence business loan interest rates.
Lenders consider the business’s age and financial status as part of their risk evaluation when deciding whether or not to approve someone for a loan or to determine the interest rate for the loan.
Businesses operating for a longer time and with a proven financial history of stability and profitability are considered less risky for lenders.
Consequently, older businesses with a healthy financial status can benefit from lower interest rates on their business loans.
On the other hand, lenders often view startups or newer businesses with limited financial history are often viewed as higher risks.
As a result, new businesses may get higher interest rates and stricter terms.
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Cash flow
Cash flow measures how much cash flows in and out of your business. It is a crucial aspect that helps businesses to operate daily.
Cash flow helps lenders evaluate your income vs. overall expenses and potential for profitability.
Businesses with limited cash flow are considered risky for lenders because they show that they cannot manage their expenses, which can include loan payments.
The lack of cash flow can even result in businesses to close down.
When you apply for a loan, lenders will review your bank statements to study the cash flow. This helps them evaluate whether your business can manage loan payments.
Positive or healthy cash flow signals lenders that your business is less risky.
In return, expect to have lower interest rates in your loan application.
Type of business and industry
Lenders also consider the type of industry your business is in to help evaluate the proper loan terms and interest rates.
Lenders prefer to work with businesses assured of expanding or producing steady profits. If your company is like this, you can secure lower interest rates.
However, industries such as agriculture, construction, and restaurants are considered risky fields.
These types of businesses are often given higher interest rates
Credit Score
Credit scores are also a huge factor that impacts the interest rate of business loans.
A credit score is the starting point for lenders to measure your riskiness as a borrower, especially with traditional banks and lenders.
A credit score represents the borrower’s creditworthiness and credit history.
Lenders use this to assess the risk of lending money.
Higher credit scores show that you are responsible and capable of repaying loans on time, indicating lower risk and can result in a much lower interest rate.
Conversely, a poor credit score may result in higher rates, stricter terms, or even loan rejection.
Here’s a quick guide on credit score ranges and what they usually mean:
- Poor: 300-579
- Fair: 580-669
- Good: 670-739
- Very good: 740-799
- Exceptional: 800-850
Collateral
Collateral is a valued item pledged as an added security measure to help secure a loan.
Secured or asset-backed loans usually have lower interest rates than unsecured ones because they require collateral.
Traditional banks insist that borrowers provide collateral in exchange for loans.
There are many types of collateral, including real estate, business equipment, inventory, cash, and investments.
If the borrower cannot repay the loan, the lenders have the right to seize the agreed-upon collateral and sell it to regain their losses.
Collateral makes borrowers appear less risky, which can help business owners secure lower interest rates on their business loans.
However, not all businesses, especially startups, are large enough to provide collateral.
Unfortunately, not every business can access assets large enough to qualify as collateral. This is especially true for younger, smaller companies.
On the other hand, collateral-free loans usually have higher interest rates because lenders will take on more risk because there is no collateral to secure the loan.
Loan Amount and Duration
The loan amount and duration can also impact the interest rate for loans.
Expect higher interest rates if you plan on taking out a large loan with a much longer duration.
Lenders can also view larger loan amounts as having higher risks since they involve repaying significant amounts of money, which can increase the chances of default.
Longer loan durations usually mean higher interest rates since long-term loans are often perceived as riskier than short-term loans.
However, some lenders may still offer low-interest rates with longer loan durations, especially secured loans, as these are more likely to have steady cash flow.
Other Existing Loans
Multiple outstanding loans are often viewed as risky to lenders.
Existing loans can create a disorder in cash flow and the borrower’s ability to manage loan payments, resulting in higher interest rates or even rejection of a loan application.
Lender Policies
Lastly, interest rates can also affect the different policies lenders have.
Every lender is unique and has different policies that borrowers should know before taking out a loan since it greatly impacts the interest rates and loan terms.
For instance, some lenders specialize in specific types of loans or fields and may offer lower interest rates for these loans.
Lenders have different standards that impact interest rates. Some may require a more extensive evaluation, while others require higher credit scores.
External Factors Affecting Business Loan Interest Rate
Besides the factors we discussed above, several external factors can still affect business loan interest rates.
Here are some external key factors:
Inflation
Inflation can affect the interest rates on your business loans.
If the inflation is currently high, lenders might raise rates to protect their return on investment.
On the contrary, when the inflation is low, lenders may be more willing to give lower interest rates.
Economic State
Similarly to inflation, the overall economic state can impact loan interest rates.
During economic growth, lenders may be willing to offer lower interest rates to charm borrowers.
Unfortunately, lenders may charge higher interest rates during economic downturns.
Government Policies
Changes in tax rates or some regulatory policies can also affect business loan rates.
Government policies play a crucial role in shaping the business lending game.
It can influence the economic growth and operations of businesses.
Government policies can affect the interest rate, banking regulations, and fiscal policies.
Factors That Influence Business Loan Interest Rates: Summary
Several factors can impact loan interest rates; both can be internal and external to businesses.
Factors including cash flow, business age, financial health, credit scores, lender policies, collateral, outstanding loans, and cash flow can all influence business loan interest rates.
On the other hand, external factors, such as inflation, economic status, and government policies, can also play a part in determining interest rates.
The interest rate on a loan is a crucial aspect that every entrepreneur should thoroughly analyze before taking out a loan.
A comprehensive idea of rates and terms can help you get the most suitable loan for your business.