A business loan can be a useful tool in any entrepreneur’s toolbox, whether you’re starting out and looking to score your first funds or trying to scale a growing enterprise.
But before applying for a loan, remember that unlike grants or venture capital, you’ll need to pay back the full amount borrowed, plus interest. Therefore, be sure you have a solid plan to maximize the value of your newfound money.
Next, consider the total cost of borrowing. Interest is attached to all loans, whether it’s a student loan, a mortgage, or a business loan. The difference in interest rates can result in savings or costs that really add up over the lifetime of the loan — so the rate that you’re getting is an important consideration when determining which loan product is right for you.
What are business loan interest rates?
A business loan interest rate represents the amount a borrower pays back to a lender, in addition to the principal, as a cost of borrowing; it’s usually calculated as a percentage of the total amount borrowed.
APR, or annual percentage rate, is the total cost of a loan, including the interest rate and fees. It’s the best measure for understanding and comparing interest rates. Fees commonly associated with business loans include:
Origination fees, which is the cost of processing a new loan
Underwriting fees, which go to the underwriters who review your financial documents
Closing costs, which can include a loan-packaging fee or a business valuation
Business loan interest rates can vary widely depending on the borrower’s financial history, the lending institution, and what’s happening in the economy.
US lenders typically set interest rates off the prime rate for the major banks, which is 4% as of May 5. You can think of the prime rate as the amount a bank would charge its least risky customer, but getting offered the prime rate is rare.
When calculating interest rates, lenders will add percentage points to the prime rate. The number of percentage points added to your loan offer will typically depend on your company’s financial and credit history, as well as your personal financial and credit history.
For example, after considering an entrepreneur’s loan application, a bank decides to tack on three percentage points to the prime rate. That borrower will then get an offer of 7% for that loan product.
How to prep for your business loan application
To give yourself the best shot at getting a good loan offer, start preparing well before you need the money. “Start earlier than you think you need to,” advises Aviv Baron, founder of financial services firm Direct Payment Group. “You can either get the money fast, or you can get the money cheap.”
Here are a few things you’ll want to have in place before reaching out to lenders:
Write a business plan: A good business loan should help your business expand, and a good lender will want to understand how you’ll use the funds to achieve growth. Defining how much money you need and sketching out a plan around how you’ll use it is important to lenders.
Improve personal and business credit: Lenders will look at your personal credit history when considering your business loan application. They can lean on it heavily, especially if your business doesn’t have an extensive credit history yet.
Borrowers with high credit scores tend to get offered the lowest interest rates. (A “good” score is about 670 or higher.) In order to build solid personal and business credit, be sure to pay off your entire credit card bill every month before the due date. (The auto-pay function is your friend!)
If you don’t have time to build up super solid credit, at least pay off your credit cards and make sure you’re using less than 30% of your max credit amount before submitting your application.
Establish a relationship with a lender: If you’re looking to take out a business loan in the next 6+ months, approach a lender now for a small loan and pay it back on time every month. This will build credibility with the lender, and once you’re ready to take out a larger business loan they may offer you a favorable interest rate.
Gathering your documents
In addition to a business plan and credit history, you’ll need to submit several financial documents once you’re ready to apply for a loan. Lenders often need:
Income tax returns: It’s common for lenders to ask for your three most recent personal and business income tax returns
Projected financial statements: Forecasts detailing income you expect to make in the future
Bank statements: Typically one year of personal and business bank statements
Accounts receivable and accounts payable info: Documents detailing the money owed to your company as well as the money you owe to vendors
Average business loan interest rates
Prime rate changes over time, which is the basis for many bank loan interest rates.
Now that you have your financial ducks in a row, it’s time to dig into loan types and interest rates.
Business loan interest rates can vary widely depending on the loan type, lending institution, and borrower. But remember, having strong personal and business credit, substantial credit history, and a convincing business plan will be key to qualifying for the best offers.
Here’s a breakdown of common types of business loans, along with average interest rates.
Small Business Association (SBA) loans
The SBA is a US government agency that supports small businesses and entrepreneurs. You apply to SBA loans through a credit union or bank, but these loans are backed by the US government. This means that if you default on your loan, the SBA will buy back a portion of your loan from the lender.
SBA loans usually come with some of the lowest interest rates and the longest repayment terms, but tend to have strict qualifications, and it can take a long time to get the funds. Interest rates for a typical SBA loan range from 6.25% to 8.75%.
SBA loans are great for startups that don’t have established credit yet, especially in cases where the founder(s) have solid credit histories. But it is possible to get an SBA loan with less than stellar credit.
Conventional business loans
Similar to an SBA loan, you can apply for a conventional business loan through a credit union or bank. Conventional business loans have stricter credit score requirements than SBA loans and tend to come with shorter repayment terms and higher interest rates, depending on your credit history.
Funding from conventional loans, however, typically comes through much more quickly than SBA loans, and they require a lot less paperwork to apply for. If you need money in a pinch and have a high credit score, a conventional loan may be a good route for you.
Current conventional business loan rates range from 2% to 13%, and established businesses with solid credit histories are most likely to get the lowest rates.
Online business loans
Online lenders tend to be more lenient with credit score requirements and ask for less paperwork than conventional banks. However, loans cost more, with interest rates ranging from 7% to 99%.
Online loans might work well for entrepreneurs who’ve been in business for at least a year, need money fast, and don’t qualify for a conventional bank loan. But be aware of the high rates.
Short-term business loans
Many lenders also offer short-term business loans, which usually need to be repaid within one year. Interest rates on these loan products can range from 3% to 50% or higher. The rates can be relatively low during good economic times, but are often quite high during a recession.
Short-term business loans can be helpful if your company needs an influx of cash to get through a tough quarter, purchase seasonal inventory, or handle emergency expenses. But these loans tend to require frequent repayments, sometimes weekly or even daily.
The process for applying to a short-term business loan is relatively simple, but you’ll need to prove that you can pay the money back. It’s critical to show strong projected earnings — a startup trying to land a short-term loan will likely need to provide lenders with projected cash-flow statements and sales forecasts for the next 3-5 years.
Other types of business financing
Some other kinds of business loans include:
Lines of credit: A business line of credit is similar to a credit card, in that it lets you borrow up to a certain dollar limit. This type of financing is more flexible than a loan because you only pay interest on the amount you end up using; it’s possible that you borrow $5k one month, $15k another month, and $3k the month after, as your business needs change.
Equipment loans: This is specifically to finance pieces of equipment you need to run your business. Terms and interest rates depend on the equipment type and how long it’ll hold its value for, and some lenders will finance 100% of the equipment cost. For this type of financing, the equipment you buy becomes collateral for the loan.
Merchant cash advances: A company advances your business a sum of money, and you pay it back as a percentage of your sales, plus interest and a fee. This type of financing is easy to qualify for but should be seen as a last resort, as it can carry an APR that’s higher than 100% and may lead you into a debt cycle.
Fixed vs. variable interest rates
Business loan interest rates can be fixed or variable. A fixed interest rate stays the same over the lifetime of the loan, so the borrower can rely on making the same payments year after year. A variable interest rate can change during the loan term, depending on the market — if prime rates or other indexes go up or down, it will change the interest rate you pay.
Fixed interest rates:
Often start out higher than variable rates
Come at a lower risk to borrowers
Offer predictable monthly payments
Variable interest rates:
Often start out lower than fixed rates
Come at a higher risk to borrowers
Can mean monthly payment changes, if the prime rate or market changes
Current business loan interest rates
Unfortunately, there isn’t one central place to see current business loan interest rates, as they vary widely depending on the lender, the loan type, and the borrower’s financial history.
Once you determine which loan product would best suit your business, comparing offers among a variety of lenders is your best bet. If you’re eager to know what kind of interest rates you might be looking at, try plugging your numbers into a business loan calculator, like this one from NerdWallet.
What is a good interest rate on a business loan
Generally speaking, the lower the rate the better. But interest rates shouldn’t be your only focus when deciding between loan options. There are many things to consider beyond the interest rate, such as:
Quality of the lender: Is the institution you’re dealing with a direct lender? Meaning, are they providing the loan to you directly or sourcing it from somewhere else? If you’re dealing with a direct lender, it’s more likely you’ll have the opportunity to build a long-term lending relationship.
Watch out for lenders who are trying to rush you into a loan agreement. “If a bank or lender is rushing the business owner, [the borrower] should be concerned,” says RJ Grimshaw, CEO of UniFi Equipment Finance, a lender that finances business equipment.
Depending on your company and how you’re looking to use the money, it might be important to go with a lender who’s a specialist in your space. There are lenders that focus on loans specifically for restaurants or gym franchises, for example.
Loan term: When thinking about the full cost of your loan, it’s important to consider your loan term. If you have the choice between a 10-year loan with a lower interest rate or a three-year loan with a higher interest rate, you might end up paying more with the 10-year loan, because you’d be paying interest for a longer period.
However, your monthly payments for a 10-year loan may be lower, since you have longer to spread out the cost. The right loan term for you will depend on your business’ current revenue and cash situation.
Bottom line, interest rates are a key consideration when evaluating business loan options. But they’re not the only consideration.
It’s important to build up strong credit so you can put yourself in a position to get offered the lowest interest rate possible. But, not all entrepreneurs have time to do this and, depending on your business plan, securing a higher interest rate loan could be the right call for you and your business, especially if a cheaper loan isn’t available.