Business Loan Rates for Small Businesses Explained
Sometimes a business loan is the little boost your business needs to kick-start its growth journey. However, small business owners are often subjected to higher business loan rates.
To help you find the right funding option for your SME, in today’s article, we will talk about what contributes to interest rates, the impacts of APR on the general cost of business borrowing and why smaller businesses are likely to pay more.
What Are Interest Rates?
When taking cash from a lender, you agree and are expected to pay back the borrowed amount (the principal) along with an additional amount, called the interest. Effectively, interest rates are the primary cost of borrowing money, as they can vary greatly depending on the conditions of your loan.
Interest rates are agreed upon within the terms of your loan. They could be fixed or flexible as per your agreement with the lender. The interest is charged based on the amount you borrow. Typically, additional costs associated with taking a business loan, such as set-up fees, arrangement fees, insurance premiums and early repayment fees, have no impact on your interest rates.
Things To Consider About Interest Rate Charges on Business Loans
Loans and other forms of borrowing can really help a small business, so they are valuable resources to consider when creating a business plan. The cash freed up via a successful loan application can help you purchase raw materials, stock or even support the acquisition of real estate for new shops or factories. Your business can see substantial growth as a result of a cash injection from a business loan, making the employment of new staff smoother or easing the pressure on irregular cash flow.
However, there are a number of things to consider regarding your interest rates before you take out a small business loan:
Overall Cost of Borrowing
It is important to make sure that the business loan rates you agree on should always be less in cost than the overall revenue that your business can produce when using the cash injection. The loan you take out must be repaid regardless of the success or failure concerning revenue, according to the agreed terms, including interest. This is why it is crucial to determine the overall cost of borrowing, including the relevant business loan interest rates.
Deductible Expense
While the loan itself isn’t subject to tax relief, the interest rate is classified as a deductible expense from your final profit/loss statement at the time of your tax bill calculations. This allows you to claim a tax deduction on any loan interest your company pays if the funds borrowed are used exclusively for commercial purposes.
Your Credit History
Business loan rates will often vary depending on the credit history of you or your business, the time you have been trading and your financials so far. The best business loan rates will often be given exclusively to companies with a reasonable length of establishment, with good financials, positive credit history and good repayment record.
How Do Interest Rates Work?
Interest rates will be put down as a percentage of the principal that is to be paid to borrow the funds for one year. To put this into perspective, check out the following example:
If your business borrows £1,000 with an agreed interest rate of 10 per cent per year, the total amount expected to be repaid at year’s end will be £1,100 (principal plus £100 interest).
So, how are the interest rates you are expected to pay determined?
The Bank of England specifies a base rate – also referred to as the bank rate – that is the interest rate that the Bank of England charges commercial borrowers who are relatively large in stature. Such borrowers will then loan the money on, charging an interest rate that is higher than the bank rate, so they can reap some profit.
Knowing this, you may find yourself asking why the small business loan rates vary so wildly. Simply put, it is a matter of risk.
Every lender will have to leverage what is expected to receive in payment for granting a loan (for smaller lenders, they may have had to pay more themselves) against the likelihood of the borrower paying back the entirety of the principal and interest at all, or whether the borrower defaults on the loan.
So, why are smaller businesses and start-ups at an apparent disadvantage when it comes to seeking a business loan? As smaller businesses, generally, have only been trading for a short period, they may be offered a loan but at an interest rate that is higher than more-established businesses, to mitigate some of the risk taken by the lender.
Lenders will seek assistance in estimating the risk of lending to businesses by referring to your up-to-date credit score via a credit reporting agency.
The Costs of Interest Rates: Explained
Interest rates will be written down as ‘X per cent per annum’ – this is the basic interest rate. Importantly, there are additional fees and costs associated with loans that businesses must remain aware of.
In addition to the interest rate, your business may be required to pay other fees, one being a set-up fee. Even if requiring up-front payment, fees will increase the cost of borrowing money, an example is below:
Your business borrows £1,000 with an interest rate of 10 per cent per annum, with a set-up fee of £50 at the beginning of the loan, the total cost of borrowing by the end of the year is £1,150.
The extra £50 paid as a set-up fee works out as the equivalent of paying an extra 5 per cent on a year-long business loan, meaning that your total finance cost equals £150: representing an annual percentage rate (APR) of 15 per cent. APR is a cumulative amount that includes fees, interest and other costs of borrowing, meaning businesses must look at APR when considering a business loan, not merely the interest rate.
Multiple lender types offer different ways to gain loans and funding including banks, credit unions, specialist business lenders and building societies. You should always consult different lenders and options to establish the best course of action for your business.
Types of Security Necessary For a Good Business Interest Rate
Businesses that own property – such as a factory, shop or vehicle – may well be able to negotiate better interest rates with lenders by putting up said property as a security against the loan. Be aware, if your business were to default on the loan, the lender may have the right to seize the security and you will lose the right to that property.
Where you are purchasing physical assets for your business, such as buildings, equipment and transportation, the asset itself may directly act as a security against the loan.
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