How Small Business Loan Interest Rates Are Calculated and Negotiated

Getting a small business loan can be a great way to get the capital you need to start or grow your business. But before taking out a loan, it’s important to understand how interest rates are calculated and negotiated – this can have a big impact on your total borrowing costs. In this article, we’ll break down the key factors that go into small business loan rates so you can make an informed decision.

The Basics of Interest Rates

An interest rate is essentially the cost of borrowing money, expressed as a percentage of the loan amount. With a small business loan, this percentage is applied to the principal (the amount you borrow) and you’re required to pay it back along with the original principal.

Interest rates can be fixed or variable:

• Fixed rates stay the same over the full loan term. This means your monthly payments don’t fluctuate.
• Variable rates can go up or down over time, depending on market conditions. This means your monthly payments can change.

Interest rates are usually expressed in terms of Annual Percentage Rate (APR). This factors in both the interest rate and any fees or costs associated with the loan. APR gives you a complete picture of the annual cost of borrowing.

How Lenders Calculate Interest Rates

Lenders use several factors to calculate interest rates on small business loans:

• The Federal Funds Rate – This is the interest rate banks charge each other for overnight lending. Though not directly tied, the Fed Funds rate influences rates on business loans.
• Prime Rate – This base rate is what banks charge their most creditworthy customers. The prime rate strongly influences variable small business loan rates.
• Credit Score – Your personal and business credit scores are a major factor. Better scores mean you’re less risky, so lenders offer lower rates.
• Collateral – Loans backed by collateral like real estate or equipment are less risky for lenders. This can mean lower rates.
• Revenue and Time in Business – More established businesses with higher revenues are seen as less risky borrowers. This can earn lower rates from lenders.
• Loan Term – Longer loan terms mean extended risk for lenders, so they tend to charge higher interest rates.
• Loan Type – Secured loans backed by collateral generally have lower rates than unsecured loans. Government-backed loans offer below market rates.
• Competition – When lenders compete for business, they may offer more competitive rates to win clients.

Typical Small Business Loan Rates

Here are some typical APR ranges for common small business loan types:

• SBA Loans – Around 6-10% APR with government guarantee
• Bank Loans – Approximately 5-12% APR
• Online Loans – Can range from 10-35% APR
• Equipment Financing – Around 6-16% APR
• Invoice Factoring – Rates based on invoices, often 2-15%
• Merchant Cash Advance – Not technically a loan, but equivalent to 60-99% APR
• Hard Money Loans – Usually around 7-15% APR
• Business Lines of Credit – Approximately 6-20% APR

Keep in mind, your specific rate depends on your unique credit profile and financial circumstances. Those with strong credit scores, collateral, and healthy businesses get the lowest rates. Startups and riskier borrowers pay higher interest rates.

How to Negotiate for Lower Rates

When applying for a small business loan, don’t just accept the first interest rate you’re offered – try negotiating for a lower rate. Here are some tips:

• Shop around – Compare rate offers from multiple lenders. Having options gives you leverage to negotiate.
• Ask for discounts – Many lenders offer rate discounts for things like setting up autopay, maintaining a deposit account with them, or taking a business training course.
• Pledge collateral – Putting up assets as collateral can lower rates substantially. Even if not required, offer to secure the loan.
• Shorten the term – Opting for a shorter repayment term often earns a lower rate. Just make sure you can afford higher monthly payments.
• Make a larger down payment – Putting down 20% or more upfront shows the lender you’re invested in repaying. This can mean better rates.
• Boost your credit score – Improving your personal or business credit score before applying can help you qualify for lower interest rates.
• Bring in a cosigner – Adding a cosigner with better credit can persuade lenders to reduce rates. Just know they’ll be on the hook if you default.
• Take what discounts you can get – If you can’t negotiate a lower base rate, look for discounts like waived origination fees. It’s still savings.

With some savvy negotiating tactics, you can often reduce your small business loan interest rate by 0.5 to 2 percentage points. That can equal big savings over the life of your loan.

The Bottom Line

Interest rates have a major impact on the cost of financing your business. Take the time to shop around, negotiate the best deal possible, and fully understand the interest rate structure before committing to any loan. While getting approved is important, make sure the rate and terms fit your budget so the loan is affordable and helps (not hurts) your business. With the right loan and interest rate, you’ll be set up for success.