Almost every small business needs to borrow at some point. Getting the right interest rate can make a huge difference when it comes to the affordability of repayments. So how are interest rates calculated, how can you negotiate the most competitive rate – and what should you do if a bank won’t give you the affordable business finance you need?
What interest rate can you expect?
Loans to small businesses generally attract an interest rate of between 6% and 13%, depending on the amount borrowed and the perceived level of risk. Typically, the lowest rates will be offered to the longest-established businesses with the highest credit scores and the largest borrowing requirements, and the highest rates to the most recent businesses with the lowest credit scores and the smallest borrowing requirements.
As a rule, small businesses will always pay more interest than larger corporations, as they present significantly higher risk. The possibility of default is always a major factor in calculating interest rates, and largely forms the basis of the underwriting process. In simple terms, underwriting involves detailed analysis of your business’s finances (and potentially your personal finances too) to determine your likelihood of repaying, and will focus on your capacity to meet your current outgoings, your credit history and your collateral.
The final factor will be one outside your control: the prevailing market conditions. The base rate has been low for many years, but banks have been inherently cautious about lending since the financial crash of 2008. When banks are relaxed and capital is easy to come by, you can expect to pay less; when they are reeling from earlier losses and capital is scarce, you can expect to be penalised.
However, you can also affect the rate you receive through a few simple steps.
Six tips to improve your interest rate.
1 Make your loan payments on time and in full for two years. Generally banks look back a couple of years to see whether you have missed any repayments, and adjust the interest rate accordingly.
2 Reduce your credit balances. Your existing lines of credit will be an important factor in calculating how much you can borrow, and at what interest rate. In general, you should try to reduce your balances to below 10% of the credit available to you, factoring in the possibility of having to fund early payment penalties.
3 If unsecured lending is proving too expensive, look at secured loans. These are far less risky for lenders, so you can expect a lower interest rate and the option of a longer term. However, your level of risk is comparatively higher – you will lose the asset in question if you fail to repay the loan.
4 Make a down payment. Saving up and making a down payment will reduce the size of the loan and hence your monthly repayments (though the actual interest rate will not be changed).
5 Budget for high monthly repayments. Longer unsecured loans often come with higher interest rates, so if you can repay quickly you can obtain a more competitive rate. Budget for high repayments and pay your debts down rapidly – you will save a significant amount in interest and free up considerable working capital.
6 Consider an alternative lender. Alternative lenders apply different criteria when deciding whether to lend, and at what rate, so can be the perfect choice when banks won’t lend competitively.
Alternative lenders can be the answer
When banks aren’t keen to lend, alternative lenders often will be, and you can choose from a range of borrowing solutions.
Emergency business loans, as the name suggests, offer rapid finance when your business hits a cash flow crisis. You can typically expect to borrow between about £20,000 and £250,000, and the lender should be able to have the money in your account inside 24 hours.
With asset-based finance, you can borrow against the value of your premises, plant or equipment. Because the loan is secured, the cost will be lower and your business’s longevity, cash flow and credit score will be far less important in influencing the interest rate.
Finally, invoice finance in the form of discounting and factoring are great ways to tame a troublesome cash flow. In simple terms, they allow you to borrow against the value of your invoices (typically up to 85% of their value) as soon as you issue them. Opt for factoring and the lender will take control of your debtor ledger and use the skills of experienced credit control professionals to secure early payment from your clients – thus reducing the amount of interest you pay. With invoice discounting, you manage your own debts, which may result in slower payments but means that your clients do not find themselves dealing with a third party.
Whichever solution best meets your needs, an alternative lender will often offer a fair interest rate within a short time frame.