The bank prime loan rate, used as a basis by individual banks to set interest rates on their loan products, is currently at 8.50%, its highest level in over 20 years. For small-business owners seeking funding, high interest rates can impact their cash flow and, ultimately, their ability to repay the loan.
Lenders consider a number of factors when assessing the risk of lending money to a business and determining the interest rate that is reflective of that risk. Some of these factors — like age of the business — are outside the control of borrowers, but there are others where business owners can influence the interest rate they’re offered. Understanding these factors, as well as tactics for navigating the loan application process, can help business owners negotiate the best interest rates and terms for their small-business loan.
Build business and personal credit history
Having good credit, both personal and business, is one of the most important factors lenders use to determine a borrower’s creditworthiness and, by extension, the interest rate they’re willing to offer them. Missed payments, accounts that have gone to collection, bankruptcies and other derogatory events can all negatively impact your credit score, as well as a lender’s assessment of your credit risk.
“The main thing that affects the interest rate is the track record of your business,” says Carolyn Katz, a mentor at the New York City chapter of SCORE, a nonprofit organization offering education and mentorship to small businesses. “So an established business [usually a 2- to 3-year-old business] with a good credit record is going to get a better interest rate and have more loans available to them. For newer businesses, your personal credit and your personal expertise in the business are going to matter.”
Registering your business as a legal entity, opening a business bank account, establishing credit lines with vendors and suppliers, and making on-time payments can all help you build business credit. Before applying for a loan, also be sure to check your credit report for any errors and work to resolve them.
Have a solid business plan
Taking the time to gather and present thorough business information when creating a business plan for potential lenders can reflect positively on you and your business.
“Coming in well prepared with your financial information, well prepared with your business purpose and the story behind what it is that you’re trying to accomplish ultimately leads your banker to have more confidence in their decision to risk their capital by lending it to your business,” says Michael Sims, a market executive at Georgia’s Own Credit Union.
Lenders can also be influenced by your stated use of the loan funds, which you can outline in your business plan. If you’re seeking funding to generate future revenue, for instance, that’s helpful for lenders to know, explains Katz.
“Try to use the money that your business is already generating for soft costs like marketing and personnel. And try to use the loan for more tangible things,” says Katz. This may include the purchase of assets such as a vehicle, commercial property or equipment, for example.
Using collateral to secure funding, meaning you pledge an asset that the lender can take possession of if you default on the loan, can also improve your interest rate.
Offering an asset as collateral reduces the lender’s risk, explains Sims. Real estate, equipment, machinery, or even your inventory and accounts receivable can serve as collateral for a loan.
Select your lender carefully
Traditional banks and credit unions will typically be a borrower’s first stop when seeking funding. In addition to their own loan products, some banks and credit unions will also offer SBA loans, which are often competitively priced.
When comparing lenders, be cautious of any offer that seems to be too good to be true, especially an unsolicited loan offer, says Katz. Comparing the annual percentage rate of each offer can help you understand the full cost of borrowing — which could include fees in addition to interest rate.
To help in your search, leverage organizations like Small Business Development Centers and SCORE, which offer free services to help small-business owners access funding, including the preparation of financial information and business plans.