Loans can be a lifeline for small businesses that are just getting started, looking to grow, or need extra funds to help cover a big purchase. But before you sign on the dotted line, it’s worth knowing how interest is typically charged on a small business loan. Business loan rates can depend on a variety of factors. Here’s what you should know before taking out a small business loan.
Loan interest rates vary by type of loan
There are a few different types of small business loans, including SBA loans, general term loans, business cash advances, business lines of credit, and others. These options offer different interest rates depending on their approval process. For instance, SBA loans and traditional bank loans typically offer the lowest interest rates but require the highest qualifications. Bridge loans come with higher interest rates.
“Lenders may use a variety of rates depending on loan type or financing structure. APR, or annual percentage rate, is the most common. However, many others rely on factor rates, flat fees, weekly charges, or the prime rate,” wrote Lendio. “Understanding the differences will help you compare offers as you grow your business.”
Likewise, different types of lenders can offer different interest rates. Traditional lenders such as banks can provide the most affordable rates, but they will also be the slowest to fund. An online lender will likely offer more expensive rates and be faster and easier to qualify for.
[Read more: 15 Commonly Asked Questions About Small Business Loans]
Rates also depend on your business
The exact cost of a loan varies from borrower to borrower. There are elements of your small business that a lender will examine to determine what interest rate to offer. Some of these factors include:
- Your business credit score.
- Your personal credit score.
- How long you have been in business (new businesses are considered riskier).
- Your industry (riskier industries result in higher interest rates, usually).
- Your collateral (offering collateral to secure your loan may give you a better rate).
Of course, some of these areas are under your control while others are circumstantial. Knowing these factors can help you assess different lenders and understand why you’re being offered the rates you’re offered.
[Read more: How to Apply for a Small Business Loan for your Startup]
Fixed or variable interest rates?
Business loans are structured with either variable or fixed interest rates. A variable rate loan is one that fluctuates based on an index tied to the market. So, if the market increases, your interest rate will also increase. While you may have a lower interest rate initially, this can change over time, making it difficult to budget.
Conversely, a fixed-rate loan offers a consistent interest rate and monthly payment. It will not change over the life of the loan. This also means you can’t take advantage of market changes that could lower your interest rate.
Loan repayment term length also matters
Finally, the term of your business loan will also play a role in your rate. For instance, short-term loans will have less total interest, since you’re borrowing money over a short time period. These loans compensate with higher APRs—higher total costs of borrowing, including fees such as origination fees.
“In general, you should aim to take the shortest loan that is feasible for your business,” wrote Investopedia. “This will allow you to get out of debt more quickly and reduce the amount you pay in interest. That said, you should also be realistic about how quickly you can repay the loan. Missing payments can lead to financial penalties, or (in extreme cases) your lender seizing your collateral.”
Keep an eye out for fees, since some loans offer low interest rates but pile on additional charges.
Understanding the criteria lenders use can help you figure out where to improve to lower your interest rate. Key factors like credit scores, profitability, and collateral influence rates offered by banks and alternative lenders.
Use APR to compare your options
Speaking of fees, it’s usually best to use the APR (annual percentage rate) to compare one small business loan to another. While interest rates are important, they’re not the only thing you’ll have to pay when taking out a loan.
Lenders charge other fees, too. “Lenders add fees to cover the cost of processing applications or managing loans. Charges differ depending on the lender and loan type but can include origination, application, annual and late payment fees. Some fees are a flat dollar amount, while others are a percentage of your loan,” wrote the Wall Street Journal.
An APR includes fees as well as interest, giving your business a snapshot of the total cost of borrowing. Make sure to get the APR from each lender to understand what you’ll need to pay each month.
How to calculate interest on a business loan
There are online tools, such as this one from Bankrate or this one from NerdWallet, that can calculate what your loan will cost and how much you’ll pay each month. These tools are the simplest way to calculate interest on your loan.
If you decide to do the math by hand, you'll need the loan principal (amount borrowed), interest rate (as a decimal, e.g., 6% = 0.06), loan term (in months or years), and payment frequency (monthly is common). The simple interest formula for basic loans is Interest = Principal × Rate × Time, where Time is in years. For example, a $50,000 loan at 6% over 1 year = $50,000 × 0.06 × 1 = $3,000 total interest.
The math gets more complicated depending on the loan type. Consult with a financial advisor to get a more complete calculation that includes fees, amortization, and other variables.
APR vs. interest rate: what’s the real cost?
Interest is the cost of borrowing money, expressed as a percentage of the amount borrowed. APR goes a step further by bundling the interest rate with any additional lender fees. Therefore, APR gives you a more complete picture of a loan's true cost.
When comparing loan offers, use the APR when possible. While lenders are legally required to provide APRs for consumer loans, this doesn't apply to business loans. Many will still voluntarily share their APRs; if they don’t provide an APR up front, ask for one.
Tips for getting the lowest interest rate possible
Understanding the criteria lenders use can help you figure out where to improve to lower your interest rate. Key factors like credit scores, profitability, and collateral influence rates offered by banks and alternative lenders.
Improving your personal credit score is a good starting point. A strong personal credit score signals low risk, as lenders use it as a primary qualifier for better rates. Pay debts on time, reduce credit utilization, and check reports from Equifax or TransUnion regularly to see progress.
On the business side, lenders look for strong profitability, consistent cash flow, and at least 12 months in business to unlock lower interest rates. If you can’t meet those benchmarks, create a plan to work toward those standards and show positive trends in your financial statements. Lower or eliminate existing debt as much as possible.
Finally, consider what collateral you can offer to lower your interest rates. “If you have tangible assets to put up as security, it can make the loan cheaper,” said Paul Ciciola, Business Centre Manager, BDC. “For example, if you have a building as collateral, chances are your interest rate is going to be lower than if you have nothing or a depreciating asset like equipment.”
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