Overview
Whether you are a newly launched business or looking to expand your business reach beyond markets, the ability to raise business funds could be a make or break point for you. Though there are other sources of financing available, still countless businesses irrespective of their size or level of operations prefer business loans to meet their financial needs.
Business loans come in different varieties catering to any general or specific business requirements like managing operations, ramping up operations, purchase of machinery, managing inventory levels, and promoting business activities. Business loans could have a significant bearing on the financial planning decisions which will be repaid till the maturity date. Read further to know more about business loan interest rate and types, factors affecting interest rates on business loans and essential tips to lower interest rate on business loans.
Business Loan Rate of Interest- Meaning and Purpose
Business Loans interest rate could be defined as a certain percentage of lender charges against the total amount approved as loan. Interest payments are charged to insure lenders against risk of default by the borrower. The interest payments on the loan are an added sum on top of the principal loan amount, and adding up with other charges such as processing fees, stamp duties, fees and charges, etc. added up to the total cost of borrowing impacting periodical repayments to be made over the period of maturity. The percentage of interest levied on a business loan might vary for every business depending on risk associated with the transaction and financial health of the business.
The overall cost of borrowing for a business is dependent upon the lender, type of credit facility sought, and the amount involved. A lower rate of interest could help a business considerably, helping the burden on their business finances. It could also help to plan budgets, estimate expenses and manage cash flows to ensure a positive contribution to overall business growth.
Comprehending the interest rate, entrepreneurs and businesses could appraise different loan options available and pick the one aligning with their business financial health.
Strategies to Reduce Interest on Business Loan
Factors that affect business loan interest
Credit Score
Higher the credit score, lower the interest rate. The credit score for a business is a key determinant for the interest rate applied for business loans. It is represented by a three-digit number which contains details about the creditworthiness and credit history of the borrower business. The credit score allows lenders to evaluate the lending risk for the borrower. While a higher credit score shows minimal risk of loan default leading to loans being offered at lower rates, a negative or lower credit score might cause the loan application being rejected altogether.
Businesses with a credit score of 670-850 are known to have a good credit score which allows them to negotiate favorable or lower interest rates. However, businesses with a credit score of 580 or lower may only get access to business loans at higher rates of interest.
Business Age and Financial History
If the financial history of the company is positive and loan repayment history is good it will impact the new loans negotiations by giving the company an upper hand, hence being able to reduce interest rate. Next, the business longevity and its financial history have an adequate impact on lowering the interest rate for business loans. Lending institutions consider these factors as a portion of their risk assessment measures while defining loan interest rates.
Needless to say, businesses who have been in existence for a longer period with stable finances are regarded to be less risky for default prompting loans at lower interest rates. On the other hand, newly launched businesses with limited financial history might find it challenging to establish their financial viability and may access funds at higher rates of interest.
Also, lenders might also contemplate upon other factors such as financial history, sales records and profits, and consistent business inflows while evaluating business loan applications. Accordingly, businesses with consistent business inflows have higher chances to get business loans at lower interest rates.
Furthermore, lenders might also take into consideration the Debt-to-Equity ratio of the business entity. Businesses where the debt level is higher than the equity of business might also be perceived as risky by lenders prompting higher rates of interest and vice-versa.
Loan Amount and Duration
Smaller loan amounts and shorter repayment duration reduces interest rates on loans for businesses. Therefore, the factor impacting the interest rate on business loans includes the sum of the loan and the duration for which it is sought by the borrower. Logically, larger loan amounts for a longer maturity period may result in higher interest rates as it surges the risk of default for the lender.
Longer-term loans are supposed to be riskier than shorter-term loans since there is more time available for other factors such as changes in the business, industry or economy, etc. which might affect the ability of the borrower to repay loans. Thus, lenders may levy higher interest rates for longer-term loans to compensate for rising risks.
However, certain secured loans may bear lower interest rates owing to their possibility of steady stream of income over a more prolonged period.
Availability of Collateral
Assets, securities or property which could be pledged to secure repayment of the loan amount and reduce the lender risk, this in turn reduces the interest rates on business loans. Where the borrower fails to repay the loan amount, the lender could seize the collateral to compensate himself against such default. Therefore, business loans secured by collateral carry lower rate of interest whereas unsecured business loans come with higher rate of interest.
Furthermore, the type and market value of the collateral might also impact the interest rate on the business loans. For instance, collateral which could be easily liquidated with stable market value (like real estate, inventory, equipment or securities, etc.) have more favorable loan terms and lower interest rates are likely to be. Contrarily, collateral free loans carry a higher rate of interest due to the higher risk of default on the part of the borrower.
Industry and Market Conditions
Market and Industry trends have a significant impact on lowering the interest rate offered by the lenders who consider these factors while assessing the default risk on the business loans and determine the interest rate. Accordingly, the current economic state, market trends, competitors and the potential for market disruptions or demand changes, etc. might lead to higher or lower rate of interest for the borrower.
For instance, businesses functioning in cyclical nature industries, or those subject to rapid technological advancement might be offered business loans at higher rates of interest for higher chances of market disruption and potential decline in demand. The way out is to secure your business through long term deals with clients/suppliers, hedge risks through various measures and have forward /backward integration to avoid dependability.
Similarly, business industries with high levels of competition may also face higher interest rates due to the increased risk of market saturation, price wars, or reduced profit margins. Conversely, businesses in industries with low levels of competition may choose access to loans at lower rates of interest due to market disruption and increased stability.
While determining the size of the business and its market position, lending institutions might offer loans at favorable interest loans to larger businesses with a stable market position.
You may not be able to change the nature of your business to reduce your interest rates but your financial stability, market credibility and collateral position will strengthen the borrowing power and hence reduce the interest on business loans. Even in risky business formats the business may take steps to hedge the risks by securing its position in the market.
Lender Terms and Conditions
Every lender has its own terms and conditions which affect the terms of the loan agreement along with interest rate terms. For instance, certain lenders specify certain kinds of loans focusing on certain industries with specific lower rates of interest for those business loans. These may be due to the government promoting special industries or special loans for companies operating in certain SEZs. All these factors can also reduce the interest rate on a business loan for companies that adhere to the government guidelines or fall under the special criterion. A company may choose to get its registered offices in such SEZs to be able to take advantage of schemes that help in better loan interest terms.
Further, there are other lending institutions who may choose to cater to smaller businesses with poor credit history or limited financial resources in exchange to charge higher interest charges to insure themselves for rising risk of default.
Lending institutions should also consider the relationship between the borrower business and the lender while deciding interest rates. Where the borrower has an established relationship with the lending institution like credit history for repayments, long standing accounts, etc. it offers favorable loan terms and lower interest rates. Hence it is advisable to keep your banking relationship with primary banks professional and
Likewise, interest rates might also be impacted by the underwriting requirements by different lenders. For instance, interest rates offered by a lender may vary depending upon extensive documentation requirements or higher credit scores or more.
Secure the Best Business Loan offer with the Lowest Interest Rate
Considering the factors impacting the interest rate on business loans, it is necessary for businesses to manage these interest rates to save money on funds and divert them towards business operations. Here are some necessary tips to reduce interest rates making business loans affordable for you-
Boost your business profits to Reduce Interest Rates
Lending institutions intend to offer credit facilities to businesses with steady sales records and profits. For the same reason they seek audited copies of financial statements preferably with history of profitability, current sales which reflect the profits trending higher or lower. Further, borrower businesses shall have a favorable debt to equity ratio with continuous efforts to reduce their outstanding debt.
Furthermore, identify the areas where your business spending occurs regularly to find whether funds could be saved in any manner. Businesses monitoring their financial expenditures and making timely adjustments demonstrate sound financial health making lenders to offer low interest loans due to lower risk of default.
Conduct a Thorough Analysis of your Financial Health to Reduce Interest Rates
Next, the borrower business organization shall perform a financial check up of the business organization to find out whether the business meets the eligibility criteria preferred by traditional lending institutions. It includes attributes such as –
- Business longevity
- Industry to which the business belongs to
- Sales records demonstrating profitability
- Credit history and Creditworthiness
Now, once you have checked the details carefully and found weaknesses, resolve them before making an application for a business loan as it could interest rate applicable on the loan.
Conduct Thorough Research on Lending Institutions Available to Reduce Interest Rates
In order to access business loans at lower rates of interest, businesses need to do adequate research on the lender and lending facilities offered by them. Not only will it help the borrower entity to get the right kind of loan facility but will also ensure loans at best possible rates.
While conducting the research the borrower shall consider the following –
- Identify your business requirements (whether any general or specific objective) to determine your ideal loan category. If the business funding resources change over time to time, availing a line of credit might be more beneficial.
- Determine the amount you wish to avail as a business loan and the same comes within the loan limits offered by lenders.
- Next, make a list of lenders including banks, non-banking financial institutions, online lending platforms, peer to peer lending platforms and credit unions, etc. Now, draw comparisons between them depending upon the general loan terms and interest rate offered. Also, consider availing loan facilities from your regular lenders as it might help you to negotiate favorable terms on the basis of customer loyalty.
- Consider lenders who allow businesses to check eligibility and applicable interest rate without harsh credit score requirements.
- Prefer lenders with a good reputation known for disbursing funds timely and maintaining excellent customer support services.
Consider Adding Collateral or a Cosigner to Reduce Interest Rates
For lending institutions higher risk implies higher reward factor as a measure to ensure proper risk management. It could come in the form of personal guarantees, pledging collateral, or adding a co-signer to the loan application.
Businesses who lack credit score might implement certain ways to avail business loans at lower rates. For instance, they could consider adding collateral to the loan apart from personal guarantee of the business owner to make full repayment where the business fails.
Likewise, mortgaging assets such as machinery or equipment or inventories or real estate, etc. could help to lower the rate of interest as the lender can compensate himself by liquidating the asset in the event of default by the borrower.
Moreover, businesses with inadequate creditworthiness might also benefit from adding a co-applicant for the business loan application. Generally, such co-signer shall have excellent credit history and better creditworthiness, which reduces the risk of default for the lender.
Further, adding personal guarantee by the business owner or adding a credible guarantor to fulfill debt liability in the event of default by the borrower business.
Adjust your Business Plans to Reduce Interest Rates
Making a loan application for your business requires the same kind of commitment and efforts as making necessary changes in your resume before a job application. Having a good business plan might not make up for businesses with low credit score or adverse debt to equity ratio, but it could enable confidence in the lender in the ability of the borrower to fulfill his debt commitment. Thus, it would help borrowers to seek low-interest rate business loans.
Consider Shorter Maturity Periods to Reduce Interest Rates
Even though business loans with long maturity periods come with cheaper monthly installments, interest payments over longer durations means more costs of borrowing for the business. Whereas, choosing business loans with shorter periods generally come with affordable interest rates, and lesser interest payments reduce overall cost of borrowing for the borrower.
Make Additional Payments or Payments in shorter durations to Reduce Interest Rates
Another strategy to reduce interest rate on loans includes making additional payments or making businesses in shorter durations (weekly or biweekly) which could help to reduce costs on interest payments and lessening the outstanding debt. Thus, accelerating the loan repayment schedule could help lower the interest accrued on the business loan.
Consider Refinancing or Consolidation of your Existing Business Loans to Reduce Interest Rates
Businesses who have a long business relationship with the lender could seek either refinancing or consolidation of different debts under varying rates of interest. Refinancing or consolidation will help the borrowers to simplify payments, increase their cash inflows, tracking their finances and above all seek lower rates of interest leading to savings in costs for interest payments. Check with the lender whether there is any possibility to do balance transfers. Keep yourself updated about the current market rates and use the information while negotiating for a lower rate of interest on your consolidated loans.
Communicate Frequently with your Lenders to Reduce Interest Rates
Businesses should foster long-term business relationships with their lenders as part of their growth strategy. Building trust and confidence among parties could be encouraged through prompt response to queries, upholding transparency, and making timely repayments on existing loans. Thus, where there is a long history of cooperation and partnership between the parties, borrower business is in a much better position to seek loans at lower interest rates.
Ensure Proper Negotiation to Reduce Interest Rates
Lastly, in order to get the best deal borrower businesses need to negotiate the terms like any other business transaction. For which, businesses need to emphasize on their financial health, creditworthiness, viable business model, growth and expansion plans, and above all their outstanding credit history. Lenders do not want to lose clients who can help them sustain a long-standing business relationship, and thus may comply with your requests creating a mutually beneficial situation.
Mitigate Business Risks to Reduce Interest Rates
In order to be able to negotiate better business loan terms, the business may consider mitigating risks by various factors. These risk management strategies may include measures like diversification of revenue sources by getting into ancillary businesses, improving and managing cash flow of the business so that there is no cash crisis due to unforeseen circumstances or during regular business operations. The business may also work towards reducing its operating costs over the period so as to be able to reduce its loan requirements or reduce interest rates due to better operational management.
Take the Help of Experts to Reduce Interest Rates
Managing everything on its own may be a tough task for the businesses, especially the SMEs.They may not have the bandwidth to handle all banking related negotiations, report preparations and even staff to be able to negotiate better with the banks even after having a sound and favorable position in terms of business stability. This is where you may need the help of experts like BankKeeping who will help your business at each stage of attaining a business loan, reducing interest or even negotiating the terms that may have any restrictive covenants thereof. The loan needs to be serviced and all necessary paperwork can be handled by experts so that there is no delay in submissions and no penalties levied by the banks. The experts can also ensure that the lenders or banks cannot charge extra interest than necessary or agreed upon.
Conclusion
Since business loan interest rates are affected by a lot of internal and external components, businesses should consider them carefully before applying for credit facilities. Having the idea about how, when or where to pursue business loans from lenders, might make the process to access funds less overwhelming for businesses and entrepreneurs. Better understanding about factors that affect business loan interest rates could help businesses to get loans at minimal interest rates helping businesses to make sound financial decisions. Also, keep track of finances and make repayments a priority for effective debt management and sustainable business growth.
We at BankKeeping are fully equipped to help you in your banking journey. We can be your guide through the cumbersome process of applying and servicing your loans, along with negotiating terms and conditions based on the Bank Sanction Letter. BankKeeping can be your guide through the banking journey starting from reducing interest, getting more credit, maintaining a timeline for regular submissions, interest reduction and more loans on the same collateral.