All loans come with repayment terms. Most of which require you to make monthly payments for a fixed amount of time, depending on the repayment terms you negotiated with a lender. While many small business owners opt for traditional bank loans, many other loan programs are available through online lenders, credit unions, and the Small Business Administration (SBA). Nonetheless, interest rates will vary between the different types of business loans available and where you choose to submit your loan application.
However, with so many loan options available, it can be difficult for business owners to choose a repayment plan that works best for their business needs. This is especially true if you aren’t already aware of how interest rates on loans function in the first place. With that said, there is no need to worry as we will cover the topic of business loan interest rates in depth.
Additionally, we'll also provide you with guidance on comparing loan rates and preparing your loan application. Therefore, keep reading to learn more about interest rates on business loans in 2022.
What is the average interest rate on a business loan in 2022?
The average interest rate on a business loan in 2022 from a traditional financial institution ranges from 2.54% - to 7.02%. However, the reality is that not all small business owners will qualify for lower interest rates due to several eligibility requirements that we will discuss later in this article. Furthermore, depending on your business needs, you can either opt for a short-term bank loan or a long-term bank loan, which will factor into the rate you are given by the bank.
Luckily, other loan programs besides traditional bank loans may provide you with more favorable rates. Let's take a closer look at these options below in more detail.
Small Business Administration (SBA)
SBA loans are another popular choice for many business owners looking to borrow money. The administration is funded by the government and functions to provide entrepreneurs with assistance in successfully launching their businesses. While there are different types of business financing opportunities from the SBA, many entrepreneurs opt for the SBA 7(a) loan.
This loan provides you with flexible financing options, meaning you can use the borrowed money for the following:
· Working Capital
· Purchasing real estate
· Purchasing inventory, equipment, machinery, furnishings, supplies, materials, and fixtures
· Building a new business location or renovating a current location
· The acquisition of another business
· Refinancing current business debt
Again, while the U.S. Small Business Administration has numerous financing options, beyond the SBA 7(a), you can expect average business loan rates of 3.75% - 10.25%.
Business Line of Credit
Further, a business line of credit is similar to having credit cards. Borrowers are pre-approved for a loan amount they receive in a lump sum. However, you only pay interest on the money you borrow from your total funds. This means you can continue borrowing money from your line of credit as long as it does not exceed your credit limit.
In addition, using monthly payments, business owners can pay off their debt and replenish their available funds. Therefore, if you are responsible for paying your monthly statement, this is an excellent method of increasing your business credit score. Moreover, while the interest rate will largely be determined by your credit score and other factors, you can expect an annual percentage rate (APR) between 7% - and 79.8% to cover additional fees.
Merchant Cash Advances
While not technically a loan, Merchant cash advances can provide business owners with cash quickly. For this to work, borrowers will apply for a loan amount or cash advance usually approved swiftly. The money is then provided to you in a lump sum within 24 hours of the approval. You give a portion of your business's debit card and credit card sales with fixed daily or weekly sales.
With that said, merchant cash advances have high annual percentages rates ranging from 20% to 250%, which are determined by a factor rate between 1.2 and 1.5 (repayment amount x cash advance amount). In addition, while cash advances can offer quick funding, they can rapidly put your business in debt if used irresponsibly.
Lastly, invoice factoring is a type of loan that provides you with immediate cash flow for your business. If you have invoices you are waiting to be paid by clients, you can sell your outstanding invoices to a third-party company.
This provides you with a large portion of the invoice balance in cash. The third-party company will then receive payment from your clients and give you the remaining amount owed, minus their fees. Interest rates for invoice factoring can range from 10% to 60%.
What factors affect business loan interest rates?
Furthermore, now that you have a better idea of what kind of business loan options you have and their associated interest rates, we must go over what types of factors will affect the rate you are provided by a lender.
That way, you can fully prepare your finances and other associated requirements beforehand. Additionally, these factors may also help you negotiate lower interest rates. Remember, it’s always best to be over prepared than underprepared, especially when dealing with loans. Here is a closer look at these factors.
1. The type of lender you choose.
The first factor determining the interest rate you are provided when taking out a loan is who you want to borrow money from. While credit unions and financial institutions typically offer the lowest interest rates, they also have stringent requirements on what the funds can be used for and who is accepted.
On the other hand, online banking websites offer financing options that are more flexible with eligibility requirements and fund usage. However, they can be on the pricier side when everything is said and done.
2. Your personal credit score.
Your credit history and credit score are a massive factor when it comes to qualifying for small business loans. Remember, lenders are cautious about who they will allow borrowing money from them. Therefore, a higher credit score and history will indicate to them that you are responsible for paying back funds.
In addition, it may also provide you a lower rate. With that said, just because you have a bad personal credit score doesn't automatically mean you won't be approved for a loan. In fact, a lot of online lenders are more open to providing individuals with unfavorable credit history loans. Just keep in mind that you are more likely to be presented with higher interest rates.
Further, if you are worried about your credit score, the best course is to begin working on paying off your debt quickly. Alternatively, if you don't have a long credit history, it may be worth activating a new credit card and working on increasing your score before applying for a loan.
Collateral refers to assets such as a house, car, or other personal funds that lenders accept as a form of security for allowing you to take out a loan. While not all business loans require collateral, some lenders may be willing to provide you with a lower interest rate if you can give some. However, it is essential to keep in mind that while collateral may offer lower interest, it can put your assets at risk of repossession should your business go into debt and fail.
4. The loan terms
Moreover, the repayment terms for your loan will also factor into the interest rate you pay. Typically, business loans with more extended repayment periods will have lower monthly payments than short-term loans. However, remember that loans with more extended payment periods are likely to be more costly over the life of the loan itself.
5. The type of loan you choose to apply for
As evidence, the type of loan you choose to apply for will also factor into the interest rate you pay. Therefore, it is vital that business owners weigh their options by determining what they will need the funding for. That way, they can focus on applying for loans that will benefit them the most, rather than spending too much time on loans that won't be as helpful.
6. Personal and business finances
Lastly, your personal finances and business finances can also affect the loan interest rate you are offered. If your business is already up and running and is looking to expand, lenders will take a look at how long your company has been operating, what your annual revenue is, your business credit score, the type of business you own, and what you are looking to spend the money on. This will ultimately determine what kind of risk is attached to lending you money which equates to the interest rate you will be offered.
Do business loans have fixed or variable interest rates?
Moreover, small business loans may have fixed rates or variable rates, which will determine your repayment plan. Now, you may be wondering what the difference is between variable-rate loans and fixed-rate loans. So, let’s take a closer look at these differences in more detail.
Fixed variable interest loan rate
With a fixed, variable interest rate, business owners are provided with a monthly repayment plan that will never change over the lifetime of the loan. Not only does this give them peace of mind knowing that the rate they have will never get higher despite market fluctuation, but it also offers more of a snapshot of how your business can budget each month in order to pay off your debt. Fixed variable rates are generally associated with longer payment terms and are best used when financing new real estate or refinancing any debt.
Variable interest loan rate
On the other hand, a variable rate typically carries an initial rate that is lower than fixed-rate interest. However, this rate is subject to change as the market fluctuates. As a result, you can expect to have your monthly payments change often. In addition, it can also be more challenging to make budgets that are accurate and long-term. Nonetheless, variable rates can provide the lowest interest rates at times but also the highest. Therefore, this is something to consider when choosing which type of loan agreement you wish to apply for in the future.
What are loan fees?
Generally speaking, loan fees are a part of borrowing money that is often inevitable in most cases and are in addition to the interest rate you will pay. The number of loan fees you pay will vary contingent on:
· Your credit score
· The type of loan
· The lender
· The amount of money you wish to borrow
· The repayment terms
Regardless, your lender should be transparent with you on what you will need to pay at all times. If they are not, then it may be worth applying with another lender as you do not want to be charged high, unexpected hidden fees. Here is a closer look at the most common types of loan fees for business loans you may be required to pay.
1. Underwriting fees
Underwriting fees are associated with the lender's determining what type of risk you are. This includes reviewing documents, verifying information, investigating bank statements, credit history, and more.
2. Origination fee
Origination fees are a one-time upfront cost that is charged in order to process the new loan.
3. SBA loan guarantee fee
An SBA loan guarantee fee is an additional fee that varies between 0% and 3.75%. However, this is determined by the size of the loan you wish to apply for. Therefore, you can expect a higher percentage fee with a larger-sized loan.
4. Closing costs
Lastly, closing costs are expenses concerning the cost of funding your loan transaction. This can include legal fees and is generally applied when you undergo a business acquisition or apply for commercial real estate loans.
How to compare business loan rates
Furthermore, now that you have a better idea about the different types of business loans, their associated interest rates, additional loan fees, and eligibility requirements, you may have some questions about comparing loan rates.
Typically speaking, the easiest way to compare loan rates is with their associated annual percentage rate. This yearly rate includes the interest rate and loan fees that we just mentioned. This will provide you with a broader idea about what you will pay monthly once you have gotten your loan.
However, keep in mind that these rates will vary according to the factors we mentioned about, along with how financially sound your personal finances and credit score are. Alternatively, you can use a business loan calculator that will help you break down your monthly repayment costs depending on the information your lender provides you with.
Documents you need when applying for a business loan.
Moreover, when applying for a loan, borrowers are required to provide lenders with specific documents as a part of their loan application. And while these documents will vary depending on who you apply with, here are some of the standard documents required. That way, you can be fully prepared and hopefully expedite your application process from beginning to end.
· Personal credit scores and history
· Business credit score and history, if applicable
· Annual business revenue and profits
· Your time in business
· Your debt-to-income ratio, if applicable
· List of collateral is required to secure your loan
· Proof of the industry you operate in
· A business plan
· Personal bank statements
· Copy of your commercial lease, if applicable
· Employee identification number
· Legal contracts and agreements
· Incorporation documents
· Indication what you wish to use your business loan for
· Personal income taxes
· Business income taxes
· A balance sheet
· Disclosure of any other debt associated with your business or personal finances
· Business license
· Business permits
· Copies of payroll records
· Business insurance plans
· Ownership and affiliation
· Your diverse license or federal passport
Again, while this is not an exhaustive list of documents you may be asked to provide, this can help you get a better idea of what you need to collect if you cannot find a list on the small business lender’s website.
Final thoughts on interest rates on business loans
Interest rates associated with business loans can be confusing, especially if you have never taken out a loan before. However, now that you have read through our article, you should have a better understanding of the different types of loans available, their associated costs, and how interest rates can vary depending on whether it's fixed or a variable.
Nonetheless, it's essential to sit down before submitting a loan application to determine what your business needs are. That way, you can find the best loan that works for you without wasting time applying for ones that won't benefit you and don’t have low interest rates.