Business owners can negotiate for lower business loan interest rates from lenders on a case-by-case basis. And Wheeler Group is here to provide guidance on dealing with lower business loan interest rates from lenders.
Before we start, it is essential to understand the nature of business loan interest rates. Read through to find out.
Understanding Business Loan Interest Rates
But, a business loan interest rate is the additional money the bank charges in exchange for the proceeds received from the loan application. As a result of the interest rate, a borrower pays an extra amount for borrowing the money.
A flat interest rate illustration:
- Loan amount: $1,000,000
- Loan tenure: 1 year
- Interest rate: 5% p.a.
- Total interest rate payable after 1 year: $1,000,000 x 5% p.a. = $50,000
- Money to be paid back to the bank after 1 year: $1,000,000 + $50,000 = $1,050,000
In the example above, the borrower pays an extra $50,000 to access the $1,000,000 loan, whether to open a new store, hire more workers, or pay off suppliers.
What is a business loan interest rate?
For all types of loans, banks have a minimum interest rate, the interest rate a lender charges its most creditworthy borrowers, commonly referred to as the prime rate. Now, the prime rate is partly dependent on a bank’s cost of funding, which is made up of interest-bearing instruments such as customer deposits and other forms of borrowings.
The 2 critical components of business loan interest are prime rate and risk premium. During loan application, the bank collects various documents related to the borrower. It uses such information to assess the likelihood of loan repayment and then determine the relevant risk premium to levy on the loan.
How do banks calculate interest rates?
There are a few ways to calculate interest rates on loans. More often than not, the effective interest rate is higher than the advertised interest rate advertised on billboards or any marketing materials, as the actual payable interest expenses depend on how these interest rates are calculated.
Below are some common ways to calculate business loan interest rates:
- Nominal interest rate: The rate stated on the loan agreement. However, this does not reflect the actual borrowing cost as the interest rate does not consider the compounding effect or any fees or charges associated with the loan.
- Flat interest rate: Flat interest rate appeared to be lower than the nominal interest rate and seemingly more intuitive. But again, a flat interest rate does not reflect the “true” borrowing cost. This is a method of calculating interest where the interest is charged on the original principal amount throughout the loan tenure, i.e., the reducing balance of the principal loan amount is not considered when calculating the interest expense, regardless of how much has been repaid.
- Effective interest rate: This is the interest rate that borrowers should seek. Effective interest rate reflects the actual cost of borrowing, considering the compounding frequency and any fees or charges associated with the loan. The effective interest rate is calculated by raising the ratio of the nominal rate and the compounding periods to the power of the compounding periods and subtracting one. No need to get all technical; search for “effective interest rate calculator” in the browser.
- Factor rate: This is another standard method of calculating interest where the total repayment amount is determined by multiplying the principal amount by a decimal number representing the borrowing cost. The factor rate is not annualized and does not account for compounding or fees. For example, loan amount of $1,000,000 for one year at a factor rate of 1.2, a borrower will pay $1,200,000 in total ($1,000,000 x 1.2), equivalent to an effective interest rate of 20%.
What is the Average Business Loan Interest Rate?
With the above explanations, a clearer understanding of business loan interest rates can be gained. Consequently, it becomes apparent why interest rates for small businesses are higher than for larger enterprises or corporations. This is due to the business’s diminutive stature and scale, rendering it more susceptible to adverse impacts from a challenging economic environment. According to the Fed’s official data released in the 4th quarter of 2022, the average small business bank loan interest rate ranged from 5.11% to 10.46%.
However, untamed inflation prompted the Fed’s rapid rate hikes, making borrowing more expensive for consumers and businesses. Resultantly, the prime rate stands at 8.25% as of June 2023. As the lenders use the prime rate as a floor when determining the business loan interest rate, we should generally expect higher borrowing rates in 2023.
Factors Affecting Business Loan Interest Rates
Business owners with weaker credit profiles will be charged higher interest rates to compensate for the increased risks of non-repayment. Notwithstanding, the small business loan interest rate could be minimized by knowing banks’ key assessment criteria.
- Financials: Factors such as the business’s profit and cash flow are significant considerations for banks when determining business loan interest rates. Business owners should strive to improve their financial metrics over an extended period before applying for a loan to enhance the likelihood of securing lower rates. Proper bookkeeping will be a big plus. In this regard, Wheeler Group can provide valuable assistance by compiling financial forecasts and projections.
- Personal credit score: The credit profile of the business owners has significant bearings on the borrowing costs too. Business owners should maintain good credit history by making sure repayments are made on time, such as settling credit card outstanding balances (instead of minimum payment) and minimizing personal loans or cash advances. Wheeler Group has the expertise to work with lenders to provide loans based on recourse only to the business, but in some cases, a personal guarantee may be required.
- Personal wealth and assets: Lenders assess borrower’s personal wealth, savings, liquid investments, and assets like a residential property as indicators of repayment capability. This wealth information is crucial when lenders consider a business owner’s personal guarantee.
- Collateral: The value and type of collateral the borrower provides affect the interest rates, as it reduces the lender’s risks.
- Loan structure:
- Loan tenure – short-term loans typically have lower interest rates compared to long-term loans
- Interest rate – variable and fixed rates impact the interest charged on the loan
- Additional features – early repayment options, overdraft facilities may come with higher interest rates
- Other external factors:
- Government policies – governments may introduce support packages with lower interest rates to assist businesses during challenging times
- Lender’s growth strategy – specific lenders trying to grow their market share may be more lenient in their approval.
- Interpersonal relationship – of course, let’s not forget that interpersonal relationship is essential in all dealings. Build good relationships with your bankers and keep them close; you never know when you will need their services!
What Is the Interest Rate on a Business Loan – Top Banks Comparison
Having reached this point, it is likely that many of you are curious about the specific interest rates applicable to business loans. After all, the magic number is what matters. See below for a list of top banks offering business loans as of June 2023. Do note that rates and terms change frequently depending on movement in the banking industry and the broader economy.
Bank of America
Typically offers secured and unsecured term loans, business lines of credit, SBA loans, and other business-related loans. Generally, secured loans have higher borrowing limits and potentially lower loan interest rates.
| Loan Amounts | Interest Rates | Loan Terms | Minimum Time in Business | Minimum Annual Revenue |
|---|---|---|---|---|
| $25,000 and up | As low as 5.50% | Up to 15 years | 2 years | $100,000 |
Wells Fargo
Despite having relatively lesser loan products and lower borrowing limits, Wells Fargo has been named the top lender of commercial/ multifamily mortgage loans in 2022. The bank also offers lines of credit, SBA loans, and business credit cards.
| Loan Amounts | Interest Rates | Loan Terms | Minimum Time in Business | Minimum Annual Revenue |
|---|---|---|---|---|
| $5,000 and up | As low as prime + 1.75% | Up to 25 years | Undisclosed; likely 2 years | Undisclosed |
U.S. Bank
U.S. Bank has a lesser footprint when compared to the banks as mentioned earlier. The bank tends to be more digitally focused and may be suitable for young and small businesses given its startup-friendly loan requirements. Amongst others, it offers term loans, SBA express loans, and equipment finance loans.
| Loan Amounts | Interest Rates | Loan Terms | Minimum Time in Business | Minimum Annual Revenue |
|---|---|---|---|---|
| Up to $12.375 million | As low as 5.99% | Up to 25 years | Generally 2 years | Undisclosed |
Chase
Like other banks, Chase offers term loans, commercial real estate financing, and SBA loans with a comprehensive suite of business-related solutions.
| Loan Amounts | Interest Rates | Loan Terms | Minimum Time in Business | Minimum Annual Revenue |
|---|---|---|---|---|
| $50,000 and up | Undisclosed | Up to 25 years | Undisclosed; likely 2 years | Undisclosed |
Citibank
For business borrowers, Citibank offers term loans, business lines of credit, and other related business loans. However, the bank does not explicitly provide equipment loans but keeps the flexibility of term loans open for such purposes.
| Loan Amounts | Interest Rates | Loan Terms | Minimum Time in Business | Minimum Annual Revenue |
|---|---|---|---|---|
| $5,000 and up | Undisclosed | Up to 25 years | Undisclosed; likely 2 years | Undisclosed |
Summary
All in all, negotiating lower business loan interest rates is possible by understanding the factors that affect interest rates and utilizing strategies to improve the borrower’s financial profile.
A brief recap, key factors include financial metrics, personal credit score, personal wealth and assets, collateral, loan structure, and other external factors. Building good relationships with bankers is also beneficial.
When comparing top banks for small business loans in 2023, options include Bank of America, Wells Fargo, U.S. Bank, JPMorgan Chase, and Citibank, each offering different loan amounts, interest rates, loan terms, minimum time in business, and minimum annual revenue requirements.
By conducting thorough research and negotiation tactics, business owners can strive to secure more favorable interest rates on their loans.