There is numerous large and small business that is established and operational. On the establishment of any business, there might be the need to borrow loans from lenders such as banks and invoice factoring for various purposes. There might include the need for capital for expansion, fees, and other purposes. Hence, when borrowing loans from lenders, an interest rate is imposed on the business. It is important to know the basics of average interest rates on business loans, as making a smart and effective choice is important for any business to flourish. This article will discuss the average interest rate, the fees imposed, various lenders, and their interest rates in depth.
What Is a Business Loan?
Business loans are of various types. These include installment loans, lines of credit, equipment loans, and commercial real estate loans. It can be used to pay for office leases and pay the employee. These loans have interests imposed on them which must be repaid by the borrower along with the principal amount. There are various factors taken into consideration when imposing an interest rate on a business loan. These include the qualifications of a borrower, the type of loan, and the lender.
What Is an Average Interest Rate on Business Loan?
On receiving any loan from a lender, the total interest to be paid is calculated by multiplying the total loan amount (principal amount) by the interest rate. Amortization allows the same payment throughout the loan period. It is the scheduling process for a fixed-rate loan. It is divided into equal payment values on a monthly or yearly basis. These payments are invested in the principal amount rather than the interest.
Difference between Interest Rate and Annual Percentage Rates (APR)
Both the interest rate and APR measure the same thing but have a slight difference. The average interest rate on a business loan is the cost of borrowing money from a lender, which is generally expressed as an annual rate. The APR, however, measures the sum of the total cost of borrowing the loan. This includes the sum of all fees, such as the application or origination fees. The value of APR is, therefore, more than the interest rate value.
When borrowing loans, it is more important to look at the APR as it covers all the fees associated with borrowing the loan. The average interest rate on a business loan does not cover that or provide information regarding it.
The Average Interest Rate on Business Loans by Lender
The average interest rate on business loans is normally around 3% to 7%. However, the interest rates might vary depending on the lender. Loans from lenders, such as banks or credit unions, can have Annual percentage rates (APRs). These rates are low and can vary from 3% to 7%, while alternative or online loans have very high-interest rates that range from 7% to more than 100%.
In terms of national and regional banks, the annual Average Interest Rate (AIR) has an average value of 2.54% to 7.02%, according to the data from the Federal Reserve, which accounts for 6.24% of the average interest rate on business loans (SBA). In 2020, banks imposed the lowest interest rate on loans. Loans backed by the Small Business Administration (SBA) also offer competitive rates.
In terms of Foreign Banks operational by U.S. branches, the AIR is 1.45%-5.66% which does not account for interest rates on business loans. Finally, when it comes to online or alternative lenders, the annual interest rate is on average 13.00 to 71.00% which accounts for 4.39%-7.01% of an average interest rate on business loans.
The rates stated factor in finding the compound annual interest, length of the terms, and the loan amount. The effective annual interest rate does not have any fees that increase with the cost of the loan, such as the closing fees or other fees.
Other Business Lenders
Alternate lenders impose higher interest rates due to the fact that they have fewer eligibility requirements and faster underwriting processes. One such example is that lenders may impose criteria on the business for it to qualify for a loan which could be that it must be functional for 6 months and have a minimum annual revenue of $100,000 to qualify for a loan. Lenders also provide an option for the return of credit decision in a minimum time frame. Keeping the minimum demand for eligibility, these lenders are beneficial for businesses that are not bankable such as startups, low revenue businesses, or applicants with lower credit scores. There are multiple alternate lenders available such as Balboa Capital, BlueVine (business loan), Big Think Capital, Credibility Capital and Credibly that provide annual percentage rates (APRs) ranges of 3.00% – 30.00%, 7% – 30%, 15.00% – 78.00%, 6.99% – 21.99%, 9.99% – 36.00% respectively.
Average Small Business Loan Interest Rates Based on Loan Product
This type of loan is an important factor to consider as it can affect the interest rates. As opposed to banks or SBA loans which impose averages APRs of 2.58%-7.16% and 5.5%-11.25%, respectively, the alternative methods such as merchant cash advances or invoice factoring will impose higher APRs from 20.00% to 250.00% and 13.00% to 60.00%, respectively. Online Term Loans impose an average APRS of 7.00%-99.70%, while Lines of Credit imposes 2.58%-80.00%. Therefore, it is a smart alternative to stick to conventional methods of the loan rather than alternative lenders. However, the advantage of alternate lenders is that they provide a wide range of loan products. Conventional banks provide term loans and lines of credit, but alternate lenders will offer the aforementioned as well as special financing, which includes accounts receivable financing, merchant cash advances, or invoice factoring.
Factors That Affect Average Interest Rate on Business Loan
There are numerous factors that can affect the interest rate imposed on business loans. They are stated as under:
- Credit Profile
Lenders that provide loans will evaluate both the personal and business credit score before imposing loans and interest. This is done with the intent of finding out whether the business owner will be able to repay the debt on time. They have a certain criterion of minimum credit scores before providing the loan. These vary depending on the lender. Banks, for example, require FICO credit scores of 680 and above, while other alternative lenders require very few credit scores such as 500 only. Businesses with higher credit scores are paid fewer interest rates as compared to those that have fewer credit scores. Hence, the credit score will determine the average interest rate on a business loan.
- Business financials
The contemporary and future projected business finances are also looked into by lenders during the application process. They take into account the relevant documentation and business plan that will provide the time frame of the business, cash flow, business income, profitability, and the minimum amount of annual revenue required from the business to generate. The documentation must also explain the plan on how the loan will be utilized as well as the long-term benefits of the loans to the business.
- Lender relationship
The lender relationship is also an important factor to consider that will affect the average interest rate on business loans. Businesses that have a deposit account in a lending institution or have a history of receiving loans from a particular institution will be imposed lower interest rates and reduced fees. This is applicable to both banks and alternate lenders. Therefore, building a strong relationship with one particular lender or institution rather than multiple ones is a profitable alternative.
- Loan Type
There is a wide range of small businesses loans available and their rates vary accordingly. The ideal loans are provided by the U.S. Small Business Administration. Their rates range from 5.50% to 8%.
- Business Collateral
A better average interest rate on business loan is imposed on those that have a secured loan with business collateral which may include inventory or property. In this way, the business will be perceived as less risky because it can have assets that do not require payment.
Fixed vs. Variable Interest Rate
The option of either fixed or variable interest rates is provided to small businesses by lenders. In the case of a fixed-rate loan, the interest rate and monthly payment remain the same over time; therefore, the process of repaying the loan becomes much easier and simpler.
Lump-sum term loans usually have fixed interest rates. It is ideal for purchase for one time only and for those businesses that have financial needs for a long period of time. The needs could be due to funding a major business expansion, purchasing real estate, or refinancing debt.
A variable-rate loan varies with time. The initial rate is low, but it may rise or fall with time. This depends on the market. Budgeting may become difficult as the rates are unpredictable.
A business line of credit usually comes with a variable interest rate. It allows the borrowing and return of money continuously. This loan is ideal for businesses that do not need a particular amount of money but require quick access to money for short-term capital or emergency funds.
Types of Fees
The interest fees, as well as other fees (if applicable), need to be paid in the APRs. These fees could include the Application Fee, which is nonrefundable. The Origination Fee is imposed when processing a new loan. The labor in the processing loan is covered in the Origination Fee. Borrowers who return their loans before the designated times are imposed a Prepayment Penalty, while those who do not meet the deadline for predefined payments are imposed a Late Payment Fees. Underwriting fee is the fee collected by those who review, read and verify the documents. This includes financial statements, business plans, credit reports, tax returns, and bank statements.
Closing Costs are the fees imposed when receiving the loan which may include the loan-packaging fee, a commercial real estate appraisal, or a business evaluation.
SBA loan guarantee fee can have a rate between 0% to 3.75% based on the size of the loan. Annual service fees may range from 0% to 0.55%. Rates on loans made by the SBA are very competitive and difficult to acquire.
Qualifying Criteria
Lenders have various criteria that need to be met by borrowers. This includes their personal credit score, business credit scores, annual revenue, and profitability, amongst others. This is the case when borrowing loans from banks. In terms of online lenders, there is lenience in their qualifying criteria. Traditional lenders such as banks require a minimum personal credit score of 680 or more, minimum annual revenue of $250,000, profitability is mandatory, and the business must have been established for more than 2 years. In terms of alternate lenders, the personal credit score must be more than 600, the annual revenue must be $100,000 or more, the probability is not mandatory and the age of the business can vary from 6 months to 1 year or more.
Methods to Lower Business Loan Interest Rate
Below are the various methods to reduce the average interest rate on business loans:
Improving personal credit: Improving the credit, particularly for startups can be useful as it can create a strong portfolio and will look more appealing to lenders who will then reduce interest rate values.
Compare lenders: Lenders offer their own rates, methods, and fees. It is important to check, analyze and compare each, after which the ideal option must be chosen.
Prioritize loans from banks and the SBA: These means provide the lowest interest rates; however, the application process may be lengthy.
Choose a shorter-term loan: Choosing a smaller time frame for the return of the loan will have the lower average interest rate on a business loan.
Choosing variable-rate loans: This loan type may have chances of reduced interest rates in the future as compared to a fixed-rate loan.
Compare fees: Different lenders impose different fees. It is important to compare each and choose the one that costs the least.
The Final Analysis
The qualifying criteria, the types of fees, the types of lenders, their rates, and other factors are thoroughly discussed in this article. It was concluded that loans with fixed interest loans are an ideal option to pursue any small business. It is also profitable to opt for conventional institutions for borrowing loans such as the bank as they impose lower average interest rates on a business loan. The interests imposed by the lender depend on the requirements and the nature of the business.