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 for your venture.
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 many others. These options offer various interest rates according to their approval process. For instance, SBA loans and traditional bank loans typically offer the lowest interest rates but require the highest qualifications.
“Depending on how you’ll use the money, how quickly you need the funds, and how quickly you want to pay it off, you can select a loan type that works best for you,” wrote Lendio.
Likewise, different 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]
Depending on how you’ll use the money, how quickly you need the funds, and how quickly you want to pay it off, you can select a loan type that works best for you.
Andrew Adams, Lendio
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.
“If you have a genuinely short-term need for cash (e.g. covering payroll this quarter or buying supplies that you need urgently), a short-term loan might be a better value than a long-term loan. However, for genuine long-term needs like business expansion, a long-term loan will be better,” wrote Forbes Advisor.
Keep an eye out for fees, since some loans offer low interest rates but pile on additional charges.
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. There are other fees that lenders charge, such as an application fee, an origination fee, and a guarantee fee.
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.
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