Business loan interest rates explained

Find out what rates you can expect on your small business loan.

Rates are one of the most important factors in comparing to cost of small business loans. But it’s hard to know if you’re getting a competitive rate if you don’t know what to expect. This article tells you the average rates for small business loans by type of loan, lender and more. You’ll also learn what other costs you might want to consider.

Average rates for small business loans

You might have known that your revenue, credit score and time in business are all important factors in which rate you end up with on a business loan. But the type of loan and lender can also impact the rate you get.

Small business loan rates by type of loan

Since some business loans come with fees rather than interest, let’s take a look at how APRs compare for different loan types:

Based on rates alone, term loans are the most competitive type of loan out there — although rates can get as high as 99.7% APR if you borrow from an online lender. Short-term financing options that don’t typically come with interest like merchant cash advances and invoice factoring tend to be more expensive than the competition.

Small business loan rates by type of lender

Here’s how interest rates from different types of lenders compare:

As you can see, online lenders tend to offer higher rates than banks. In fact, the maximum rate on all three types of bank loans is several percentage points lower than the minimum rate for online lenders.

There isn’t much difference between different types of banks: Foreign banks might have a typically lower starting rate but it they also end slightly higher. However, it’s often easier to get approved for a business loan at a local bank than a large national or international bank.

Rates you can expect from top lenders

What’s a good rate on a business loan?

There is no one “good rate” for everyone. It depends on what type of financing you’re looking for and also what rates you and your business are eligible for. The more of a risk lenders consider you, the higher the rate you’ll qualify for.

Typically, business loans backed by some kind of collateral or personal guarantee have lower rates because they’re less of a risk to the lender — SBA loans have such low rates because they’re partly backed by the government.

How long you take to pay back your loan also typically affects the rate. Long-term loans and lines of credit tend to have more competitive rates than short-term business loans because there’s more time for interest to add up. Lenders who offer the lowest rates like banks generally only offer long-term loans

Who qualifies for the lowest rates?

Generally, you’ll need to meet the following requirements to get a competitive rate on a business loan:

• Good or excellent personal credit
• Positive cash flow
• Enough revenue to comfortably afford repayments
• In business for at least two years

How do small business loan rates work?

It depends on what you mean by “rates.” There are a few different types of small business loan rates you might come across: Interest rates, APR and factor rates.

Interest rate

An interest rate a percentage of your loan balance that a lender charges on a regular basis. Most business loans come with an annual interest rate (AIR), which means that that percentage applies to the loan balance over a year. However, some short-term loans come with a monthly percentage rate that applies to the balance once a month.

There are two main types of interest rates: Fixed an variable. There are also two main that lenders apply interest to your loan: Simple interest and compound interest.

Fixed vs. variable interest

Fixed interest is an interest rate that stays the same while you pay back your loan. It’s less risky than a variable rate and makes repayments more predictable.

Variable rates are subject to change, usually every month or quarter. Lenders calculate your variable rate by first give your business a fixed interest rate called a margin rate. It then adds your margin rate to what’s called a benchmark rate, which is set by a third party every month or three months to reflect trends in the lending market.

Benchmark rates are based on the lowest interest rates that lenders are charging borrowers. The LIBOR rate and Wall Street Journal prime rate are two of the most common types of benchmarks rates.

Simple vs. compound interest

Simple interest is, well more simple than compound interest. You can calculate how much you’d pay on a simple interest loan with this formula:

Principal x interest rate x loan term (in years) = Simple interest

Compound interest takes a little more number crunching to calculate. That’s because lenders charge interest on the loan principle, plus any unpaid interest that has accumulated since your last payment. Some lenders compound interest on an annual, monthly, weekly or even daily basis. The more often your loan compounds, the more you’ll end up paying in interest.

You can use this formula to figure out how much you’ll pay with a compound interest loan:

Interest rate x principle = Interest on first repayment

Interest rate x (Principle + unpaid interest) = Interest for each following repayment

Annual percentage rate (APR)

A loan’s APR is an expression of interest and fees as a percentage that applies to your loan per year. Lenders often advertise the loan’s APR, instead of its interest rate alone. That’s because it’s a more accurate picture of how much your loan will cost.

When comparing APRs, make sure you’re also comparing loans with similar terms and amounts. A loan with a 100% APR and six-month term might actually cost less than a large loan with a 5% interest rate and a five-year term.

Factor rate

If you’re looking at merchant cash advances and some other short-term term loans, you might get quoted a factor rate instead of an interest rate. Rather than a percentage, lenders typically quote factor rates as a decimal, usually between 1.1 and 1.5. Some lenders also quote factor rates as “cents on the dollar” — usually between 10 and 50 cents on the dollar.

Here’s how it works:

Factor rate x loan amount = Loan cost

Unlike interest or APR, factor rates show you a fixed cost that doesn’t change over time. That means that you can’t save on your loan by paying it off early. Typically, loans that come with factor rates have a higher cost than loans that come with interest.

What affects my interest rate?

Interest rate is based off your business’s risk to the lender. Smaller businesses with few valuable assets and a small annual turnover will likely pay a higher interest rate than a more established business.

Lenders will judge each business individually based off a few common markers.

• Personal and business credit scores

  If you or your business have a credit history littered with late payments or loan defaults, lenders will quote higher rates because you pose a higher risk. However, you may be able to offset some of this by presenting a solid business plan and attaching a brief explanation to the negative marks on your credit score.

• Annual turnover

  The amount of money your business makes each year will impact your ability to pay back your lender. However, lenders will also consider any debts you have as well — the bigger the difference between your revenue and your profits, the less you’ll be able to afford to borrow.

• Valuable assets

  Most every business has assets. These can be expensive equipment to large amounts of inventory. If you’re looking for a business loan, putting up collateral that your lender can sell in case of default may lower your interest rate.

• Loan type

  Short-term business loans often come with higher interest rates. Loans like merchant cash advances can be advantageous for small business, but because they don’t have security and are only active for a few months, the interest rate may be much higher than a 5-year term loan.

• Loan security

  Your risk changes when you put up collateral to secure your loan. Lenders may offer both secure and unsecure business loans, but generally, there will be a difference between the interest rate you’re quoted based on your ability to provide collateral. Unsecure loans pose less risk to you, unless you’ve signed a personal guarantee, but they can become much more costly to your business in the long term.

• Current and projected finances

  Your business’s financial status will always play a role in whether or not a lender approves you for a loan. Businesses that have solid selling models and make a good amount of profit will be better candidates for a loan. Business that are newer or don’t make a large amount of profits may face higher interest rates.

• Time in business

  When you’re running a startup or a small business, you may face trouble getting a loan in the first place. If you do find the right lender, your business may be quoted much higher interest rates than businesses that have been established for a few years. This is because lenders are always wary about the operating costs. Businesses that have been open for a year or more generally have an easier time finding lower interest rates.

Business loan fees

While rates are an easy way to compare, they can be misleading. Even if you’re comparing a loan’s APR. That’s because it doesn’t tell you when you’ll have to pay that fee. These are some common fees you might run into when you’re taking out a business loan.

Other factors to consider

On top of fees, there are other factors that you might want to consider when considering a loan:

• Down payments. Some business loans require you to make a down payment on the item or project you want to fund — especially equipment, vehicle loans and mortgages. Look for the “loan-to-value ratio” on these types of loans to find out what percentage the lender will cover and what your business needs to pay upfront.
• Personal guarantee. Many unsecured business loans still require a personal guarantee from one or more business owner. A personal guarantee means that you’re responsible for paying back the loan if your business can’t and might require a lien on your personal assets. It might help you get approved, but also makes the loan more risky.
• Loan term. If you’re getting a loan with interest, how long you have to pay back your loan affects your total loan cost just as much as the APR. Longer terms can make your loan more expensive but lower your monthly repayments. To keep down the total cost, try to avoid unnecessarily long loan terms.

5 tips for getting a competitive rate on your small business loan

1. Check your credit. While business credit scores exist, business loan providers more commonly rely on personal credit scores more. Check your credit report for mistakes and get a soft credit check online to learn your approximate credit rate.
2. Give yourself time. Often, the loans with the lowest rates take longer than higher-rate loans — just look at the rates on bank loans and online loans. SBA loans tout some of the lowest rates out there but can takes months to process.
3. Revisit your business plan. While not all lenders require a business plan, it can be a strong argument for your business. Make sure everything is up to date and tighten the writing to be as concise and impactful as possible.
4. Back your loan. While a personal guarantee can be a big personal risk, providing collateral or a lien on your business’s assets can reassure your lender that you have something at stake.
5. Know how rates work. Some short-term loans come with monthly interest rates as low as 1%. While that might seem like a steal compared to a loan with a 7% annual rate, it’s actually more expensive. Make sure you understand what the rate actually means for each loan before you get into it.

Bottom line

There’s no one size fits all rate on a business loan. But knowing the general range of rates you can expect on a type of loan or from a specific lender can help you narrow down lenders. To learn more about how business loans work, check out our guide.

Frequently asked questions

• What types of lenders have the highest approval rates?

  According to the Federal Reserve, community development financial organizations (CDFIs) tend to have the highest approval rate for business loans. Small banks come in second, closely followed by online lenders. Large banks are some of the most picky lenders, only approving 54% of business loans in 2017.

  Generally, businesses with more than $1 million in annual revenue had a higher rate of approval than those with smaller annual revenues.

• Do personal loans have lower rates than business loans?

  They can, though it depends on your personal financial situation. If you have poor credit, a personal loan might come with a higher rate than a business loan — especially if you have other business partners who can qualify for the loan.

• What is the average term for a small business loan?

  It depends on the type of loan you’re applying for. SBA loans can come with terms from five to 25 years. Long-term loans tend to range from one to five years. But short-term loans can come with terms from three to 24 months.

• Why is the APR so important?

  The APR of your business loan is how you can see the true cost of the loan. It takes into account the principal, accrued interest and fees. Because of this, the APR allows you to analyze multiple loans and find one that balances cost and usefulness for your business.

• What is the prime rate and how do lenders use it?

  The prime rate is based off the federal funds rate, which is the rate banks use to lend to other banks. Lenders use this to determine the interest rate attached to your loan. The better your credit and the larger your business, the more likely you’ll be offered interest closer to the prime rate.

  Some loans with variable interest rates will calculate changes based off the prime rate. This may be done monthly, quarterly or annually depending on your lender and the terms of your loan.

• How do lenders set interest rate?

  Lenders set their base rates by the market rate, which may be offered with little markup to established businesses with low risk of default. If your business is still developing, you may have to sign a personal guarantee or provide collateral to secure your loan. This will lower your risk, which will then lower your interest rate.