When considering a business loan, one of the most important questions is: What will the interest rate be? You need to know the total cost of financing to continue growing your small business, but interest is not always predictable.
Loan rates depend on variables in the economy, the lending company, the loan product, and your business. That can make it hard to calculate ahead of time. But knowing the forces behind your rate and what you can do to secure better terms will pay off in the long run.
What is an Interest Rate?
An interest rate generally refers to the cost of borrowing. It determines how much you pay to the lender in addition to the principal loan amount. We use several terms when discussing this cost, but they don’t all mean the same thing. The cost you pay for borrowing capital will be radically different depending on which term your lender uses.
An interest rate is a percentage of the total loan amount that your lender will charge as the cost of borrowing. Say the interest on your $5,000 loan is 25%. That means you will pay $1,250 on top of the loaned amount.
Factor rates are expressed as a whole number and a decimal, like 1.2 or 1.65, that you multiply by the loan amount to figure the total amount you will repay. If you borrow $5,000 at a 1.2 factor rate, you’ll repay $6,000. Short-term loans and merchant cash advances (MCAs) typically use factor rates.
Annual percentage rate (APR) is a percentage that represents the total cost of borrowing in a year, including interest and fees. For example, a loan with a 10% APR means paying roughly 10% of the loan amount in borrowing costs each year. Changing costs into APR lets you compare loans across different lenders and loan products more effectively, since other rates don’t include compounding or fees.
While shopping for loan products and lenders, ask a lender to convert your interest or factor rate into an APR equivalent. You could end up paying more than expected if you don’t understand the loan costs.
Your Credit Score
Your personal and business credit scores play a significant role in determining your loan rate. A strong credit history shows you’ve managed debt responsibly, paid on time, and avoided defaults. Higher credit scores signal lower risk to lenders, which translates into lower interest rates for you.
Generally, a credit score of 680 or higher opens the door to competitive rates, especially with banks or SBA-backed lenders. You can still qualify for financing if your score is lower, but with less favorable terms. You may have fewer lending product options and face higher rates.
Improving your credit score by 30 to 50 points can lower your interest rate. Consider paying down balances, avoiding late payments, and monitoring your credit report for errors. Minor improvements add up when it comes to securing lower-cost capital.
Collateral and Guarantees
You offer additional security when you offer collateral or guarantees to your business capital lender. You can use any asset, including equipment, real estate, or inventory. Loans secured by collateral typically come with lower rates than loans that rely only on your credit and business history.
Some lenders may also ask for a personal guarantee before loaning you money. A personal guarantee makes you personally responsible for the loan if your business can’t repay. This commitment increases your risk but lowers the lender’s risk and helps you qualify for a better rate.
If you’re hesitant to pledge specific assets, consider whether a blanket or general business lien is acceptable. That means the lender could seize all your business assets if you defaulted. Offering a lien could improve your interest rates without naming specific assets.
Loan Term Length
The length of the repayment period directly impacts your loan rate. Lenders offer lower interest rates for long-term loans than short-term loans, and the length of the repayment period impacts the total cost of borrowing.
Longer-term loans, like SBA or traditional term loans, usually offer lower rates. These loans come with more extensive documentation requirements and longer approval times. The lower cost over time makes them ideal for planned investments like expanding, purchasing property, hiring, or upgrading large equipment.
Short-term loans, between three and 18 months, often have higher APRs or more aggressive repayment schedules. These products are designed for quick capital needs and fast payback, so the cost is front-loaded.
Stretching out the repayment period can lower your monthly payment and increase the total amount you pay in interest. Let’s say you borrow $100,000 at 5% interest. If the term is 15 years, you will pay around $1,000 monthly and $75,000 in interest. If the term is five years, your monthly payment is around $2,000, but the total interest is $25,000. Always calculate the total cost of borrowing over the life of the loan, along with the monthly burden.
Lender Type
Your rate will vary significantly whether you apply through a traditional bank, credit union, online lender, or fintech platform. Each lender operates under different pricing models.
Banks, SBA lenders, and credit unions typically offer the lowest rates since they have government backing for their funds. However, government backing also means they have less flexibility in the application process and in setting terms. These are best if you meet the strict documentation requirements and can wait for slower funding.
Online lenders and alternative financing platforms offer fast approvals and looser qualifications. They may charge higher rates in exchange for speed and flexibility. It’s important to shop for loans and lenders to find the best option at the best rate. Consider nontraditional lenders if you have immediate working capital needs or want more flexibility.
How Do You Secure Better Rates?
You may not be able to control every factor that influences your loan costs, but there are ways to influence your rate and secure more favorable terms:
- Improve your credit score by reducing debt and paying bills on time
- Choose secured loans if you’re comfortable pledging collateral
- Shop around and compare multiple offers before committing
- Build a relationship with your lender to increase trust and transparency
- Keep detailed financial records to present your business in the best light
- Apply when your business has finished a strong quarter
Your Impact
A low rate is great, but it’s not the only thing that matters. By understanding how rates are determined and where you stand, you can confidently approach lenders, avoid hidden costs, and choose a loan that supports your growth. Your financial knowledge saves your small business more money than any borrowing rate.