Interest is one of the biggest deciding factors when getting a business loan because it weighs heavily on the cost of the loan and the total amount you’ll have to pay back. There’s really no way around paying interest on a business loan — it’s a staple of debt-based financing.
That being said, there’s quite a variety of interest-free financing options, too, such as 0% business credit cards, grants, and special loans. But you probably can’t rely solely on these as your go-to business funding sources. Another problem is that zero-interest loans often have a caveat, which could be in the application window, qualifying requirements, commitment to the lender, repayment contingencies, or added charges.
Let’s put a pin on zero-interest loans for now and focus on making the most of interest-based loans. More specifically, how to get the lowest interest rates on small business loans. You can make smart borrowing decisions that lower your loan rate and overall financing costs.
Read on and learn how to get the best loan rates in 2023.
What is a good interest rate on a small business loan?
It’s difficult to answer this question with a single figure, percentage, or ratio. Although ideally, the lower the interest rate, the better. Lenders can only go so low on the interest, though you can still get loan offers marked below standard or industrial rate. And speaking of standard rates, these vary depending on the loan type.
Here’s a list of average interest rates by loan type to give you an idea of what we mean by standard lending rates.
You may have noticed that we've listed the average rates in terms or ranges rather than exact figures. The gaps in between the limits are pretty large too. This is because of the many different variables that go into deciding interest rates. The idea here is to give you a ballpark figure of the rates you should expect with the various funding solutions.
Knowing the average rates means you can tell when a loan is too expensive, set just right, or a top bargain. But keep in mind that interest rates vary considerably between lenders too.
How do lenders determine a loan’s interest rate?
The second step in finding low-interest loans is understanding how lenders arrive at a particular loan rate. Lenders consider a myriad of factors when setting interest rates. Some of these factors are environmental, while others have more to do with the borrower. You might be surprised to learn that similar loan products from the same lender may have different rates for different borrowers. This is because interest is majorly based on the lending risk. The higher the lending risk, the higher the interest rate. Lenders generally quantify risk by assessing the borrower’s creditworthiness.
Here are five common factors that determine a loan’s interest rate:
Federal reserve funds rate
This is the rate at which depository institutions, such as banks, trade funds held at Federal Reserve Banks with each other overnight. Commercial banks try to stay just above this rate, which essentially sets the minimum rate for other lenders as well.
The federal reserve lending rate currently stands at 4.83. This figure is set by the Federal Reserve Board and is frequently adjusted to align with national economic performance factors such as inflation and financial demand. If the rate increases, lenders are also forced to raise the interest on their loans.
Type of interest
The type of interest on a loan also plays a big role in determining the final rate. There are several types of interest, each of which is calculated and priced differently. These are the typical types of interest you’ll often find on business loans:
- Annual percentage rate (APR)
- Fixed interest
- Variable interest
- Simple interest
- Compound interest
- Factor rate
Some lenders and loan products allow borrowers to choose the type of interest they feel is best. Though in most cases, you’ll only have a choice between variable and fixed interest. Since variable interest is relatively less risky to the lender, its rate is usually a few points lower than fixed interest.
Loan structure and terms
Financing cost is partly dependent on the loan's structure and terms. The loan's tenor, installments, amount, repayment schedule, wait time, and approval requirements are key variables in the interest equation. For instance, an unsecured same-day-approval loan will likely cost more than a secured short-term loan.
Essentially, the more lenient the lender is with the loan terms and requirements, the more they’ll charge in terms of interest. Financing conveniences such as quick approval and minimal requirements come at an extra cost.
Additional fees and out-of-pocket payments
Interest is just one of many cost variables of financing. In addition to interest, loans sometimes carry extra charges such as underwriting, transaction, insurance, and origination fees. Most lenders sum up all the extra charges and include them in the interest rate (APR). But some lenders prefer to keep the interest and fees separate, in which case the interest will be lower, though you’ll still have to pay the additional charges. You should always check for extra costs when comparing interest rates, especially on products advertising extremely low rates.
On the same note, some types of loans, particularly commercial real estate and asset financing loans, require the borrower to make a down payment on the property or asset being financed. But you can forgo the deposit and make up for it by agreeing to a higher interest rate.
Your business's creditworthiness is a key factor in loan costing and determining loan eligibility in the first place. Every time you apply for a loan, the lender will evaluate various aspects of your business to gauge its creditworthiness and quantify the level of lending risk. If the perceived risk is too high, the lender may increase the interest rate, tighten the loan terms, lower the loan amount, or, in the worst-case scenario, deny you funding altogether.
The factors that come into play when measuring a business's creditworthiness and lending risk include:
- Business credit
- Turnover and cash flow
- The business’s net value
- Existing debt load
- Business history
- The business’s industry, niche, or line of trade
- The loan's purpose and repayment plan
Ultimately, the lender just wants to know whether you'd be able to pay them back based on your enterprise's nature and financial health. If the lender doubts your repayment abilities even slightly, they’ll often try to mitigate that risk by raising the loan interest.
How to get the best interest rates in 2023
Putting together what we’ve learned so far about loan rates, here are some steps you can take to qualify for or find small business loans with friendly interest rates:
- Compare as many offers and lenders as possible before taking a loan.
- Build your business and personal credit scores.
- Go for variable-interest loans.
- Consider any extra fees when calculating loan cost.
- Keep your debt-to-income ratio low, ideally below 35%.
- Develop a convincing business plan and repayment strategy.
Get the best loan rates with Lendzero
If you’re struggling to find a good deal on business loans, it might be because you’re looking in all the wrong places. So, where should you search for business loans with the lowest rates and most borrower-friendly terms? Lendzero has your answer.
Lendzero is an online lending service that enables entrepreneurs to quickly find and compare curated funding offers from multiple competing lenders. Shopping around is the best way to land a favorable financing deal, and Lendzero lets you do so in a matter of minutes. On top of that, all the listed offers come pre-matched to your business and pre-negotiated for the best possible terms and rates. Our goal is to help SMBs and start-ups access the easy, low-cost, haggle-free financing they deserve.
Lendzero is undoubtedly the right place to start your search for low-rate business loans. Start exploring competitively priced loan offers today by signing up for a free Lendzero account.