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Business banking : What determines business loan interest rates?
Business loan interest rates vary greatly from one type of loan to another, from one lender to another, and of course, from one borrower to another. Sure, the economic environment plays a big part - you won’t be surprised that it’s harder, and more expensive to get a business loan in times of general economic downturn. Sure, competition plays a part - but rates won’t be half cheaper in the other bank anyway. So much more generally, main factors affecting business loan interest rates can be grouped in two broad categories: factors related to the business and factors related to the business owner, lender and loan. Let’s see how they affect loan interest rates.
How business specifics affect business loan interest rates
Business loan interest rates can be affected by three main factors related to the business borrowing the funds: type of business, capacity and collateral.
Capacity refers to how much money a business can borrow, which is to say, how much they can pay back and how fast. This is calculated by lenders by comparing usual monthly liabilities and usual monthly revenue. How long the business has been operating and how long it has been making a profit also makes a significant difference. Many lenders will ask accounting evidenceof two or three consecutive profitable years to accept to give out a business loan.
Type of business
Lenders will consider some types of businesses to be more secure than others. An internet start-up for example will be considered more risky than other types of businesses and be forced to pay higher business loan interest rates.
Almost every business loan requires collateral. This collateral can be company assets or personal assets of the owner. Company assets can be company-owned machinery, equipment, real estate, accounts receivable, inventory… The more collateral can be presented, the cheaper the rates will be. But bear in mind that a discount rate will be applied to the value of these assets in order to calculate the borrowing base.
How bank specifics, loan specifics and business owner specifics affect business loan interest rates
Loan interest rates will also be affected by factors related to the bank or lending institution and to the business owner himself or herself.
Type of lending institution
Different types of lenders have been found to offer different business loan interest rates:
- foreign banks seem to offer cheaper interest rates;
- specialist banks may offer cheaper rates than large retail banks;
- brokers, who are not lenders, but find the right ones, will find cheaper rates for their clients.
Different loans carry different interest rates:
- the larger the size of the loan, the cheaper the interest rate - because businesses will have more time to make repayments;
- secured business loans will also carry cheaper rates than unsecured business loans.
Business owner specifics
Because a director’s guarantee is often required for unsecured business loans, the personal credit history of the business owner or director will also come under scrutiny and affect business loan interest rates.