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Getting a business loan can help take your business to the next level if you do it right. One way to make sure you get the best deal is to get the lowest interest rate. We’ll help you demystify commercial loan interest rates in this article so you can get the best possible loan for your business.
What is an interest rate on a business loan?
Unfortunately, lenders are not on a mission to give loans for free – they make money by charging borrowers interest and fees. Interest is the amount of money, represented by a percentage, that lenders charge you for borrowing money from them.
When you take out a small business loan, the total interest you pay is determined by multiplying your total loan amount, or principal, by the interest rate you are approved for. You will repay your principal and interest during the term of your loan.
Due to amortization, which is the process of planning a fixed rate loan in equal installments, you will make the same payment throughout the life of the loan, with the first part of the payment going towards interest and the amount. remaining paid on the outstanding amount. principal of the loan. More of each payment goes to principal and less to interest until the loan is repaid.
Interest rate vs. APR
It’s easy to confuse the interest rate with the APR on a business loan. While they basically measure the same thing — the cost of borrowing — they have their differences.
The interest rate is the amount of money it will cost you to borrow money from a lender, usually expressed as an annual rate. APR, on the other hand, measures the total cost of borrowing, including fees, such as origination fees. Because the APR also includes fees in addition to interest, this figure will be higher.
When it comes to researching business loans, it’s usually best to compare APRs because they include all the fees you’ll be responsible for, unlike the interest rate. After all, a business loan may have a low interest rate, but if it’s stacked over a mile in fees, it might not be the most affordable loan.
Related: Business loan calculator: estimate your payments
What Factors Affect Business Loan Rates?
- Business credit score: Businesses have their own credit scores, just like people. Lenders typically use it to measure the creditworthiness of your business.
- Personal credit score: Lenders also take your personal credit scores into account. Your own financial habits can give an idea of how you run your business and manage your finances.
- Time in business: New businesses are riskier to lend than established businesses. Most lenders want to see that you’ve been in business for at least a year or two, depending on the type of loan.
- Industry: Some industries are riskier than others, such as restaurants. Risky industries will generally lead to higher interest rates.
- Term of the loan: More often than not, business loans with the longest terms will have the lowest interest rates. This means that lenders often charge higher interest rates for short term business loans.
- Collateral: If you put some sort of collateral in place to secure and back your loan, such as business equipment or a savings account, many lenders are willing to offer you a better rate on your loan. Pledging the collateral reduces your risk for the lender because it gives them something of value to repossess if you don’t pay off your debt.
- Type of loan: Some loan programs, such as Small Business Administration (SBA) loans, are known for their low costs. Loans from other small business lenders can have very high rates.
All of these factors are not in your control. For example, you can’t control how long your business has been in business, you can only wait. However, knowing these factors helps you decide when your business is best suited to benefit from a favorable interest rate.
Average interest rates by type of business loan
Depending on the needs of your business, you can choose from different types of business loans. Each type has different ranges of interest rates. Here is the interest you can expect to pay on each type of business loan:
How to compare business loan rates
Once you’ve decided on the type of business loan you need, prequalify and check your rate with as many lenders as possible. Specifically, make sure you get the APR from each lender to understand the total cost of the loan. Most lenders who offer a prequalification process will only perform a smooth credit check, which will not negatively impact your credit score. Prequalification allows you to see the rate and terms you can receive when you submit a formal request.
Some types of business loans, such as cash advances to merchants, use factor rates instead of APRs, and you can compare the cost with this measure instead.
Other business loan fees
In addition to the interest rate, lenders also commonly charge other fees, including:
- Original fees. These fees cover the administrative work required to process and take out your loan.
- SBA warranty fees. These fees are for SBA loans only and help cover the cost of SBA programs.
- Prepayment charges. Some lenders charge a fee if you pay off your loan before the end of the term.
- Late payment fees. If you make a late payment, you may need to pay additional late fees.
- Packing costs. Some SBA lenders charge these fees in addition to the guarantee fees.
Frequently Asked Questions (FAQ)
What is the difference between fixed and variable rates for business loans?
A fixed rate loan has an interest rate that remains constant until you pay off the loan, while a variable rate can change. Variable rate business loans usually have a lower starting interest rate, but because they can change, the amount of your payments and the total interest you pay over time can also change.
How Can You Benefit From A Low Interest Rate For A Business Loan?
What is a good interest rate on a small business loan?
The interest rate ranges vary widely depending on the specific loan. For example, traditional bank loan rates typically range from 2% to 13%, while online loans can have rates as high as 100%. Ideally, and if possible, you want to get a rate below 10%.