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If done right, getting a business loan can help take your business to the next level. One way to ensure you get the best terms is to secure the lowest interest rate. In this article, we'll demystify business loan interest rates so you can get the best loan for your business.
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What is the interest rate on a business loan?
Unfortunately, lenders aren't in the business of giving out loans for free. They make money by charging borrowers interest and fees. Interest is the amount that lenders charge borrowers for loans, expressed as a percentage.
When you take out a small business loan, the total amount of interest you pay is calculated by multiplying the total loan amount or principal by the approved interest rate. You repay the principal and interest over the life of the loan. Using our business loan calculator can help you estimate the total cost of your loan.
Amortization (the process of dividing a fixed-rate loan into equal payments) keeps your payments constant over the life of the loan, with the first part of each payment going to interest and the rest going toward the outstanding loan principal. More of each payment goes toward principal and less goes toward interest until the loan is paid off.
Interest Rates and APRs
It's easy to confuse business loan interest rates and APRs, and while they both essentially measure the same thing (the cost of borrowing), there are differences.
An interest rate is the amount it costs to borrow money from a lender and is usually expressed as a yearly percentage rate. APR, on the other hand, measures the total cost of borrowing, including fees (such as origination fees). Because APR includes fees in addition to interest, this number is higher.
When looking for a business loan, it's usually best to compare APRs, since the APR includes all the fees you incur, but the interest rate doesn't. After all, a business loan may have a low interest rate, but if it's loaded with fees, it might not actually be the most affordable loan.
What factors affect business loan interest rates?
Business loan interest rates can fluctuate, and getting the best loan rate now can affect costs later. Keep these factors in mind.
Business Credit Score. Businesses have a credit score, which is separate from your personal credit score. Lenders typically use this as a way to gauge the creditworthiness of your business. Personal Credit Score. Lenders also consider your personal credit score. Your own financial habits can give you some indication of how you run your business and manage your finances. Length of time in business. New businesses are a higher risk for loans than established businesses. Most lenders want to see that you've been in business for at least a year or two, depending on the type of loan. Industry. Some industries, such as restaurants, are riskier than others. Higher risk industries usually have higher interest rates. Loan Term. In most cases, longer-term business loans have higher interest rates. This means that lenders often charge lower interest rates for shorter-term business loans. Collateral. Many lenders will give you a loan at a better interest rate if you back the loan with collateral, such as business equipment or a savings account. Pledging collateral reduces your risk because it gives the lender something valuable to seize if you default on your debt payments. Type of loan. Some loan programs, such as Small Business Administration (SBA) loans, are known for their low costs. Loans from other small business lenders may have very high interest rates.
Not all of these factors are under your control — for example, you can't control how long your business has been in operation, you can only wait — but knowing these factors can help you determine when your business is in the best position to qualify for favorable interest rates.
Average interest rates by type of business loan
Depending on your business needs, there are many different types of business loans to choose from. Each loan has a different interest rate range. Here are the expected interest rates for each type of business loan:
Source: Federal Reserve Bank of Kansas City, SBA, Nav, June 2024
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How to Compare Business Loan Interest Rates
Once you have decided what type of business loan you need, begin the process of obtaining a business loan by getting pre-qualified from as many lenders as possible and reviewing interest rates. In particular, be sure to get the APR from each lender to get an idea of the total cost of the loan. Most lenders that offer a pre-qualification process only perform a soft credit check, which does not have a negative impact on your credit score. Getting pre-qualified lets you see the interest rate and terms you'll receive when you submit a formal application.
Some types of business loans, like merchant cash advances, use a factor rate instead of an APR, so you can use this metric to compare costs instead.
Other Business Loan Fees
In addition to interest rates, lenders typically also charge other fees, such as:
Origination fee. This fee covers the administrative work it takes to process and underwrite your loan. SBA guarantee fee. This fee only applies to SBA loans and helps cover the costs of the SBA program. Prepayment fee. Some lenders charge a fee if you pay off your loan before the end of the term. Late fee. If you make a late payment, you may have to pay additional late fees. Package fee. Some SBA loan lenders charge this fee in addition to the guarantee fee.
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Frequently Asked Questions (FAQ)
What is the difference between fixed and variable rate business loans?
The interest rate on a fixed-rate loan stays constant until you pay off the loan, while an adjustable-rate loan can fluctuate. Adjustable-rate business loans usually have lower interest rates at first, but they can fluctuate, so your payments and the total interest you pay over time can change too.
How can I get a lower business loan interest rate?
Lenders consider a variety of factors to determine the interest rate they will charge: If you've been in business for more than two years and have good business and personal credit scores, you can qualify for the lowest business loan interest rates.
What is a good interest rate for a small business loan?
Interest rates range widely depending on the specific loan and loan type. According to the Federal Reserve Bank of Kansas City, the median interest rate for small business loans was 7.71% to 8.98% as of December 2023. A good interest rate is one that is close to or below the median.