Business Loan Interest Rates: A Guide for Small Businesses
Ezra Cabrera | October 9, 2022
Small business loans can be an excellent resource for starting or growing your business. However, the only way you’ll be able to make the most out of it is by choosing the one with the best terms. In most cases, this means going with loans with the lowest rates.
Businesses will have several options when it comes to business loans. Some are tailored for a specific need, and others may provide more flexible use. As such, these loan options will have different interest rates. In this article, we’ll go over what business loan interest rates are and discuss the various factors that can influence the interest rates you’ll qualify for.
Key Takeaways
Loan interest rates will depend on many factors, but two primary considerations will be the loan type and the borrower’s qualifications.
Business loan interest rates can be fixed or variable. Variable interest rates change depending on the current state of the economy, while fixed interest rates do not change, regardless of the economy’s current situation.
When applying for a loan, lenders usually examine four factors in determining your interest rate: credit score, industry, time in business, and collateral.
What are Small Business Loan Interest Rates?
One way or another, lenders have to earn a profit. After all, they, too, are running a business. The way they earn this profit is through loan interest rates. Interest rates represent the cost of borrowing and are expressed as a percentage of the principal loan amount.
When determining how much you’ll have to pay in interest for the loan, multiply the loan amount by the interest rate the lenders offered or approved. Depending on the lender, you’ll have to repay the loan in installments on a daily, weekly, or monthly basis.
Fixed vs. Variable Interest Rate
Interest rates can also be fixed or variable. A fixed interest rate means the amount you’ll pay will remain the same throughout the loan’s term.
On the other hand, variable rates may change depending on the current economy’s prime rate. While variable rates tend to be lower than fixed rates, it carries a much higher risk for small business owners. Since the interest rates can change, the business’ daily, weekly, or monthly payments may also vary depending on how the economy is faring. The unpredictability makes it more challenging for companies to incorporate their payments into their monthly budget.
Interest Rate vs. Annual Percentage Rate (APR)
Some business owners may confuse interest and annual percentage rates (APR) and use them interchangeably. While both describe the cost of borrowing, they have their differences.
Interest rates let you know how much it would cost to borrow a specific amount of money from the lender. However, since each lender structures loan differently, some may charge additional fees on top of the interest rate. In that sense, the interest rate isn’t going to be accurate if you want to arrive at the closest estimate to the loan’s total cost.
On the other hand, annual percentage rates (APR) are considered a more effective measure of loan costs. APRs consider both the interest rate and the fees associated with the loan. The fees could include application fees, origination fees, and others.
Considering the nature of both options, you’d probably get a more accurate picture of how much the business loan would cost if you used APR. Even if the lender offers low-interest rates, there’s a chance that they might make up for the low costs by charging sky-high fees.
Average Small Business Loan Rates
Lenders offer different loan products tailored to address a specific need. As such, the average business loan interest rate will also vary. We’ve outlined the average business loan interest rates below:
SBA Loans
Interest Rates: 4% to 13%
SBA loans are government-backed loans created by the Small Business Administration that creditworthy businesses can apply for. The idea behind the financing is that the government will guarantee a portion of the loan (usually 80%). This government guarantee incentivizes banks and other lenders to extend affordable loans to small businesses.
SBA loans offer the lowest interest rates for small businesses. Banks and other lenders can offer loans with interest rates as low as prime rate + 2.75% to 3.75%.
Traditional Long-Term Loans
Interest Rates: 3% to 6%
Banks also offer low-interest rates for their loan products. The popular bank long-term loans offer millions in loan amounts with repayment periods of up to 20 years at a rate of 3% to 6%.
However, there is a catch. You need to meet their exceptionally high qualification requirements to qualify for traditional bank loans. At the very least, you need a credit score of 650 or better, six-figure annual revenue, and your business has to be operating for two years minimum. The same qualifications apply to most SBA loans.
Business Lines of Credit
Interest Rates: 7% to 25%
When banks or other lenders approve you of a business line of credit, you’ll be given a credit line with a fixed amount of capital. You can access the credit line when needed. Unlike typical business loans, where you’ll be required to use and repay the entire amount, you only have to pay the amount you used with a line of credit.
That means that if you took out $3,000 on a credit line with a $10,000 credit limit, you only have to pay for the $3,000 you used, plus the interest.
Depending on the lender you work with, business lines of credit typically come with interest rates ranging from 7% to 25%.
Equipment Financing
Interest Rates: 4% to 40%
Equipment financing provides borrowers with the funds needed to purchase equipment for business operations. The equipment will act as the collateral for the loan until the borrowers pay the balance in full.
With equipment financing, you can get up to 100% of the equipment financing with interest rates ranging from 4% to 40%.
Invoice Financing
Interest rates: 10% to 60%
Invoice financing is a funding option where businesses advance cash using their customers’ outstanding accounts receivables. The business sells its accounts receivable ledger to a third-party company, providing them with a lump sum of money upfront.
The repayment structure is different from typical business loans. With invoice financing, the financing company does the payment collection. Once the clients settle their dues, the financing company takes the amount they advanced, plus the fees, and wires the remaining balance back to you.
Given the convenience the lenders provide, they usually charge around 10% to 60% interest rates on their invoice financing products.
How Lenders Determine Your Business Loan Interest Rate
When you apply for business loans, the interest rates that lenders will offer will vary. They usually measure the risk you’re carrying as a small business owner, and they do this by examining several factors, which are outlined below:
Credit score
Just like people, businesses also have their own credit scores. Credit scores allow businesses to measure your repayment behaviors. The better payer you are, the higher your credit score will be. The higher your credit score is, the less risky your business will be, and the more likely it is for lenders to offer their business loans at a lower interest rate.
Time in business
If you’ve been in the business for a few years now, you might be doing something right. From the lender’s perspective, you are fully capable of running your business. With that, they may be able to offer lower rates on the loans.
Collateral
Businesses that can put up collateral may also qualify for business loans with lower interest rates. The asset(s) pledge will give lenders something of value they can use as an alternative payment for the defaulted loan. Depending on the lender, you can use real estate or equipment as collateral to secure the business loan.
Industry
Some industries are riskier than others. In general, businesses that offer services such as construction tend to be riskier because of their seasonality. The lenders would likely charge a higher business loan interest rate to mitigate the risk.
Note: Not all factors are within your control. For instance, if you’re a startup, you might not have an established credit score or enough business time to qualify for lower rates. In that case, the only thing you can do is continue working on improving your credit and maintaining a positive cash flow so that you can qualify for favorable rates in the future.
How to Get the Best Interest Rates for Your Business
Here are a few tips to keep in mind to improve your chances of getting the best rates regardless of the business loan you’re applying for.
Offer Collateral
Specific loan programs require collateral, such as invoice financing, asset-based loans, and invoice financing. However, offering collateral even when it isn’t needed could land you more favorable rates because small business lenders can repossess and sell these assets if you default on the loan. This lowers their risk, which could reduce the interest rate they charge.
Increase Personal Credit Scores
The higher your credit score, the less risky you are to lenders. Borrowers with lower risk to lenders may receive more favorable terms and rates. If your score is below 580, you may want to improve it before applying for a business loan. Here are some ways your can increase your credit score:
Pay your bills earlier or on time
Check your credit report and dispute any errors
Pay down existing debt
Limit new credit applications
Diversify your accounts
Boost Business Credit Scores
Aside from personal credit, you may also need to check your business credit reports. Your business credit score is an indicator of your creditworthiness, and it’s based on your company’s debt history, credit, and payments.
Here’s how you can establish a business credit if you don’t have one yet:
Incorporating your business or forming an LLC is the first step to separating personal matters from your company.
Apply for an employer identification number (EIN).
Open a business bank account.
Build a Relationship with a Lender
Banks and online lenders may be more willing to approve your application and give lower rates if you’ve previously worked with them. If it’s your first time borrowing, build a relationship with your lender and make on-time payments. This ensures you have a better chance of getting a second business loan from them.
The Bottom Line
The interest rates for business financing will more likely be affected by many factors. For instance, applying for a long-term small business loan lets you take advantage of lower interest rates, while short-term loans like invoice financing would cost you more. Your qualifications (i.e., credit score, business history, industry, etc.) will also affect the interest rates you’ll qualify for.
When looking for the best loan for your business, comparing terms from different financial institutions is always advisable. In that case, a small business loan calculator might help you calculate your expected costs. Remember that you’re taking out a loan to grow your company. That said, getting the best rates would be the best way to maximize the loan and expand your company.
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