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Growing a small business is definitely a challenge nowadays, not just because of all the competition out there, but because you have to worry about multiple facets of it, such as finance, staff, marketing, and product development, just to name a few. Another challenge is identifying and taking advantage of all the opportunities that will come your way, which a lot small businesses pass on, mainly because they lack the financial resources to pull it off.
This is quite common, but that doesn’t mean you can’t break the pattern, because there are several good options for small businesses which can be explored, and one of them includes getting a loan for your small business. Unlike some other options, such as venture capital or even crowdfunding, small business loans are good because you get to maintain full control of your business and make all the crucial decisions regarding the development of your company. You can start your own small or home-based micro business for as little as $3000.
However, as attractive as loans are, they come with interest rates, which is a pretty confusing topic for most. With that in mind, let’s try and figure out how interest rates work and as well as find the most favorable ones for your small business, shall we?
Types of Financing Options
Before we can get onto the subject of interest rates, we need to take a look at a quick overview of the best financing options for small businesses. Now, while there are so many different ones, such as lines of credit, equipment financing, MCA, or even credit cards, you should pursue those with low interest rates, such as:
- Traditional bank loans – the great thing about bank loans is their price, meaning that their interest rates are low, however, they are the most difficult to quality for.
- SBA loans – Small Business Administration loans are definitely an option you need to look into, thanks to low interest rates, even though they are not super-easy to quality for, they are easier to get when compared to traditional bank loans.
How Interest Rates Work
When looking for good interest rates online, you will notice that they are usually given as ranges. So, you will often come across an interest rate that ranges between 7.5% to 10%, for instance. That is because banks and lenders treat each borrower as a separate case, and look into the nature of their business, their plans for the future, credit history, what they intend to use the funds for, and so on.
Now, your typical rates for two types of loans we have focused on are:
- 3-6% APR – for traditional bank loans
- 5-10% – for SBA loans
Basically, if you have received an offer from a bank or a lender that is closer to or right at the lower end of the range, then you can consider that a very good interest rate. On the other hand, if you are constantly being offered interest rates which are closer to the higher end of the range, then you need to start looking into improving your standing in the eyes of banks and/or lenders.
As we have mentioned earlier, SBA loans are probably the best and most affordable option you have at your disposal regarding small business financing. One of the reasons for that is the growing number of tech-based lenders which are there to meet the needs of small businesses which have been turned down by traditional banks. The main downside of SBA loans is that they are not easy to qualify for, plus if you decide to apply for an SBA loan, it will take most banks weeks to approve and fund the loan, provided that you have met all their criteria.
Now, you will often come across lenders which charge prime interests rates. What does that mean? Prime rate is simply an interest rate which banks offer to their best/most creditworthy customers. Prime rate, in turn, is based on the federal funds rate, which is the rate used by banks when lending money to one another. If the lender considers you a riskier borrower, then they will charge you more than the prime interest rate.
The current prime rate is 5.25%, which means your business loan interest rate will be up to a few percentage points higher. To put it in simple terms, prime rate will be taken as the base rate, which will then be used to calculate your actual loan rate, taking into account risk factors, such as your personal credit score (which is hopefully above 700 if you want the lowest rate), how long you have been in business (if it’s only a few years, you will be deemed more risky), how well your business is doing financially (revenue and profit), loan repayment term length, as well as your industry.
For instance, the more unstable the industry, the higher your interest rate will be, which is usually the case with restaurant and clothing businesses, law firms, and health care companies.
The Takeaway
As you can see, there are quite a few factors which are taken account when your small business loan is being approved, and which affect your interest rate. Now that you have all the crucial information at your disposal, you will be able to do further research and eventually make a more educated choice. Good luck!
