Business Loan Interest Rate and the Effect of Bad Credit

Business Loan Interest Rate and the Effect of Bad Credit

If you’re a small business looking to borrow for your business, and you have bad credit in your history, than you probably already wondering what will be the cost of a small business loan, and is it worth it? If you have poor credit history and are in need of a loan, it is important to recognize the business loan interest rate that is associated with the loan. Unfortunately, there is no “average” business loan interest rate because there are too many variables that affect the algorithm. It all depends on the type of loan you apply for, the type of business you own, who the lender is, and your qualifications.

Business Loan Interest Rate – How does Bad Credit History Effect It?

Your personal credit score and your qualifications for a loan tend to be the most influential factor for lenders in determining your interest rate or even if they will offer you a loan. For most small businesses’ lenders evaluate your personal and businesses’ credit score and your businesses monthly or annual revenue to determine what rate or payment terms they will provide you with. If you are applying for a traditional bank business loan they will be looking at a credit score no lower than 680. If you are applying with an alternative lender a much lower FICO score of 400 or above may still be accepted, but your interest rates tend to tether on the higher side based on the additional risk to the lender.

Small Business Owner Credit Score
Your personal credit score and your qualifications for a loan tend to be the most influential factor for lenders in determining your interest rate or even if they will offer you a loan.

If you have a lower than average credit score, many private lenders will want to take into account your businesses’ finances by reviewing your monthly and annual revenue from your bank statements or merchant account records. For traditional business loans, banks usually require a personal guarantee or collateral and the value of your collateral will be a factor in determining your lending rate. On the flip side, many alternative lenders, do not require collateral even if you have a lower credit score and therefore value of it does not effect the rate. If the lender does not require collateral, they will strongly look into your cash flow to see whether or not your business is profitable, to determine if they should invest in your business and what is the likelihood of you repaying their business loan and base their payment rate accordingly. It is important to note that alternative/private lenders do not usually calculate an APR for your interest rate. In most instances, they base their rates on a system known as Revenue Based Funding (RBF). Revenue based funding allows the lender to take a small percentage of the businesses monthly sales as repayment for the loan. Therefore the rate at which you pay them back is determined by your monthly sales. This is a key benefit of RBF over installment loans because it doesn’t hurt a small businesses cash flow if they have a lower than usual sales on a particular month.

Business Loan Interest Rates
In general, the smaller the loan the shorter time you will have to pay it off, and the higher the interest rate will be.

Banks typical favor larger businesses as they tend to be more profitable and have more strict accounting records and procedures. The larger the business, the larger the amount of money they will typically borrow which means the bank is able to make more money in interest rates over a longer time period. The time and cost to review and approve a bank loan is high and as a result, banks will need to charge smaller businesses more because of the higher risk and smaller profit margins. In general, the smaller the loan the shorter time you will have to pay it off, and the higher the interest rate will be.

Traditional lenders such as credit unions and banks tend to have a lower interest rate, ranging from 5% to 13%. When borrowing from an alternative lender the rate ranges anywhere between 6% up to 20% interest. Since there is such a huge range of lending rates, it is important to do careful research before borrowing from any lender, compare rates and payment options, and you must make sure that you completely understand all terms regarding your financing.

Understanding Different Kinds of Business Loans and How They Affect Your Interest Rate

Small business loans typically fall into thee categories:

Installment Loan (Traditional Bank Business Loan):

When you borrow a sum of money and you repay it a fixed amount every month, plus interest. The average business loan interest rate tends to be a bit lower. Installment loans are generally provided by traditional lenders (banks) in the form of Small Business Administration (SBA) Loan. Interest rates, annual charges and other fees can be found here.

Business Line of Credit 

Chart - Types Of Business Loans

Business Line of Credit financing is where your lender grants you an amount of credit, much like a credit card. You may draw funds against your credit amount and pay back at least a minimum amount every month. Whatever credit that you haven’t used remains open and active until you take more. The interest rate of this type of funding is usually much lower than if you borrowed using a business credit card.

Merchant Cash Advance (MCA) and other Revenue Based Financing (RBF)

Merchant Cash Advance (MCA) and other Revenue Based Financing programs usually do not require the borrower to put up collateral to assure repayment. In additional,  non-traditional lenders usually will provide higher risk funding to business owners who may have had poor credit history in their past. Rates on a merchant cash advance can be higher than a traditional business loan depending on the lender, and many business related factors. In general, when a private lender decides to finance your company without requiring collateral, and accepts bad credit history, this is an addition risk that the lender is taking and thus they will mitigate that risk by charging higher rates than a traditional bank loan.

Thus, the type of loan you use affects your business loan interest rate. Typically, installment loans have lower interest rates because it cost less to maintain and it is a reliable income every month. The convenience of a business line of credit or merchant cash advance (MCA) comes with a cost and a risk for lenders so the interest rates are typically higher.

Should I Decide on Lender Based on the Business Loan Interest Rate?

Businesswoman Road to Decision
When choosing a small business loan, you need to be aware of hidden costs, fees, and the average business loan interest rate.

When choosing a small business loan, you need to be aware of hidden costs, fees, and the average business loan interest rate. There is no average interest rate similarly there is no “one size fits all” loan. When applying your qualifications make a significant difference in your interest rate and the size of the loan. Stay organized and gather information that presents your business in the best light possible.

Furthermore, do not be afraid to do your research on your lenders and make sure they are reliable and competitive. Also look into the different types of loans and their repayment process to determine which one is right for your business and not exclusively by the interest rate they offer. If you plan to obtain funding from an alternative lender be sure to try an negotiate rates and payment terms. Most non-traditional lenders have the ability to adjust to help meet your business needs and gain your business.

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