Interest rates on small business loans can change based on the individual applicant, as the lender uses a combination of your business history, planned use of the funds, and possibly your personal credit score if you’re making a personal guarantee. Other times, your business credit score or debt ratios may improve, making you a lower-risk borrower and positively impacting the rate you are offered.
By knowing the main reasons why business loan interest rates change when you apply, you can increase your chances of getting a lower rate by modifying your business plan, offering better collateral, and submitting additional financial documents.
Factors that can impact your business loan interest rate:
Business history and payment history
Showing a track record of operating successfully and paying back previous debts gives a lender confidence that you are a low-risk borrower. This can lead to lower interest rates. Lenders want to see that you have been operating for at least one year, as this shows your business is stable.
To help secure a better interest rate, provide your articles of incorporation and your business licenses. Copies can be ordered from the Office of Secretary of State in the state where your business is incorporated and operating. If your business is an LLC, the lender can verify your history with state records or by using your employer identification number (EIN).
Another way to show fiscal and business responsibility is through your business credit scores. Check your report from one of the three main business credit bureaus: Experian, Equifax or Dun & Bradstreet. They show the debts that count towards your score, so you can work on clearing those first.
Business financials
Demonstrating your revenue and profitability can help you get a better interest rate by showing a lender that you have the cash flow to cover the loan payments. Other financial measures a lender will look at include your debt-to-income ratio (DTI), which compares your gross monthly revenue with your current monthly debt payments and your profit margins.
Another important figure is your debt service coverage ratio (DSCR). The DSCR is specific to your business having the cash flow to cover monthly or other term loan payments.
When applying for your business loan, be sure to include:
- Balance statements for up to 3 years: Used to assess your profitability
- Income statement: Used to estimate your margin and how sustainable your business is
- A debt schedule: Outlining your current borrowing
- Tax returns for up to 3 years: Provides financial insight and shows a record of filing on time
Collateral
Collateral like equipment or real estate give the lender assets to sell off if you default on the loan, making it less risky to provide your company with financing. The higher the value of the collateral, the lower the interest rate you may get. Keep in mind: The current value won’t be the only thing your lender considers, as assets may depreciate or appreciate over time.
Here’s an example. Vehicles lose value each year, so you may pay a higher interest rate if you use them as collateral as opposed to real estate.
Collateral will be listed in a publicly available record called a UCC (Uniform Commercial Code) filing. By having the lender be specific and share VIN numbers or unique identifiers vs. a generic term like “manufacturing equipment,” it limits what a lender can claim in the event of a default and keeps other assets available for use as collateral in future financing.
Personal credit scores
For new businesses without an established history, lenders often use the personal credit scores of the owner or founders of a business as a proxy for how responsible or stable a business’s finances are likely to be.
If you can show a history of fulfilling your financial obligations and you’re free of any judgments, a lender may offer you a lower interest rate, especially if you put a personal guarantee on the business loan. As an industry average, lenders will consider your credit “good” if you have a score of 670-680 or above, while a score of 740 or above is generally considered “very good.” Just like your business credit score above, if there’s anything you can do to increase your personal credit score quickly, it may help you get a better interest rate on your small business loan.
If your personal history includes bankruptcy or defaults, business lenders may consider you a high-risk borrower and either offer higher interest rates or not approve your small business loan. According to Experian, personal bankruptcy will remain on your record for 10 years if it was a Chapter 7 bankruptcy or 7 years if it was a Chapter 13 bankruptcy.
Planned use of the funds
Showing how the funds will provide a clear return on investment may help you be viewed as a safe borrower and may help you secure a better interest rate. If your company has received a big new order and you need the financing to deliver it, show the lender how the loan will directly impact your bottom line and put you in a financially better place to repay it.
If you don’t provide a business case for the use of the funds or it looks like a risky plan, like investing in machinery to produce a new product that doesn’t have a track record of sales, you will likely be offered a higher interest rate if you get approved at all.
Include market assessments, itemization of what you expect the funds to be spent on and financial projections of the expected outcomes in your business and marketing plans. Having an estimate of your market size and value by defining your target audience and using available government information from sources such as the Census Business Builder to give an accurate measure won’t hurt your chances either.
- Market size = Target users x Number of purchases expected in a year
- Market value = Market size x Average value of purchases
When competitor information is available and you can show how the business loan will let you take their market share and what the odds are, this may display your level of business savvy and increase your chances of approval and securing a better interest rate.
Deposit on a business loan
Larger deposits on your business loan lower your interest rate because the Loan to Value (LTV) rate is lower. Loan to value is a measure of the proportion of total property value compared to the amount you’re borrowing. This is most common in transactions like real estate where you’re buying land for a new location, but it can apply to any business loan where a deposit is required.
Getting the best interest rate on a small business loan is not just about choosing between lenders but also presenting yourself as a low-risk borrower. By highlighting the health of your business and presenting your plans for the funds, you can give a lender the confidence to approve your application and provide a lower rate. The less likely you are to default, the more likely they’ll want to loan your business financing.
