For many small business owners, choosing a business loan comes down to a single factor: interest. They look at all the options they qualify for and, unless there is a clear reason not to do so, choose the one with the lowest interest rate. Since interest plays such a crucial role in this decision, it’s probably a good idea to know what kind of rates you should expect to be offered before you begin shopping for business loans. This way, you won’t be caught off guard by what you see and suddenly get the impression that this is not the right time to apply. You can get a clearer picture of the best interest rates available for you by understanding how interest is determined. Remember: There are a lot more options to choose from these days, so one offer might have a wildly different interest rates than another.
Once you realize how much interest rate can vary from loan to loan, you will likely conclude that this is far from the only question you need to answer before starting your journey. Nevertheless, here are 6 factors that determine your small business loan interest rate:
1. Financial Institution
Different financial institutions offer different levels of interest rates. Though many institutions offer a number of business financing programs, the type of institution will give you a pretty good sense of the rates for all of its loans. The lowest rates are usually from banks, which isn’t a surprise considering bank loans are among the most difficult business loans to qualify for. Slightly more expensive are business loans from credit unions, followed by peer-to-peer lenders and online lenders. The latter option is among most expensive because they are the easiest to qualify for. Interest rates from companies like United Capital Source have a much wider range because they take much more factors into consideration, which could result in offers from both sides of the spectrum.
2. Relationship With Financial Institution
Financial institutions have been known to offer lower rates for borrowers they already have a relationship with. Establishing a payment record with a financial institution shows that you will be able to repay a business loan on time. So, if you believe your business is going to need a substantial loan in the not-so-distant future, you might want to initiate that relationship as soon as possible. This could involve switching over to a new bank, or, in the case of companies like United Capital Source, taking out a smaller-sized, short term business loan. These business loans are easy to qualify for and paying them back without trouble will likely make you eligible for a larger loan with better terms.
3. Credit Score
An excellent credit score gives you access to the best interest rates on the market. Banks typically require flawless (or nearly flawless) personal credit scores, while online lenders and companies like United Capital Source often work with borrowers with credit scores as low as 500. But depending on the institution you choose, a low credit score does not automatically mean you’ll have to face absurdly high interest rates. Instead, you might be assigned a program with an unconventional repayment system, or a short-term business loan that allows you to dramatically raise your credit score with just a few months’ worth of timely payments.
4. Type Of Business Loan
The lowest interest rates are attached to business term loans, which is the primary option offered by banks. Higher rates are often attached to options with less restrictive repayment systems, like a merchant cash advance or accounts receivable factoring. As you can imagine, business term loans are much harder to qualify for than the other two options, mostly due to credit score.
Some companies like to trick unsuspecting borrowers into expensive loans by advertising low interest rates, or even 0% interest. What they don’t tell you (unless you ask) is that the loan actually carries very high fees, like closing fees, origination fees, or prepayment fees. These fees can be so high that they completely offset the low interest rate, and make the loan more expensive than another option with a significantly higher rate.
6. Finances and Cash Flow
When it comes to finances, banks tend to prioritize annual revenue and capitalization in their approval decisions. They prefer borrowers with so much money saved up that, in the event of a crisis, they could easily pay off the debt with their own funds. This makes such borrowers eligible for their lowest rates. Companies like United Capital Source, on the other hand, prioritize cash flow. The lowest rates and most convenient terms are awarded to businesses that know how to manage their finances. Strong cash flow can even offset a low credit score or low capitalization.
As you can see, perhaps the biggest factor in determining interest rate is the type of business financing institution you choose. Each company has its own criteria, so it’s up to you to pick the criteria that you can most effectively fulfill. Since there are so many options available today, a thriving business shouldn’t have to look too far for a reasonable interest rate.