By Meredith Wood, AllBusiness.com
If you’re a small business owner looking for ways to grow your business, you’ve likely investigated the possibility of acquiring some outside financing in the form of a business loan. Also known as debt financing, this form of funding can be preferable to venture capital, because you maintain control of your business rather than selling off decision-making power in exchange for capital.
That being said, the world of small business financing is complex, with many possibilities—some good, some not so good. And the last thing you’ll want to do is pay more for funding than necessary.
If you’re new to the concept of small business financing, you may not know what qualifies as a good interest rate or a bad one. With that in mind, let’s review what makes for a good interest rate for the various financing options out there and what to look for when comparing products.
What are your small business financing options?
It’s important to note that there are many kinds of financing options available to small business owners. A term loan is probably what you think of when you imagine a small business loan, but it’s far from the only possibility—other financing products may make more sense, depending on your situation.
Here’s a quick rundown of the most common small business financing options:
Traditional bank loans: A term loan from the bank, where the bank extends you a set amount of money and you repay it in installments over a set period, is still the cheapest loan product out there. It’s also the most difficult to qualify for. SBA loans: The Small Business Administration helps small businesses qualify for low-interest bank loans by guaranteeing the majority of the loan amount. This is also a difficult, competitive loan product to qualify for. Equipment financing: If you want to buy a specific piece of equipment with your capital, you can receive the exact amount from an equipment financer. Lines of credit: These flexible forms of financing are pools of money that business owners can draw from over and over again as needed. Invoice financing: Instead of waiting for a client to pay off an invoice, you can finance that invoice and receive most of what you’re owed up front. Short-term loans: These are term loans from an online lender with a short repayment period and a higher interest rate than what you might get from a bank. Credit cards: Business credit cards function as a short-term form of financing that allows you to rack up reward points as well. MCA: A merchant cash advance is not a loan—it’s when a financing company advances you cash in exchange for a piece of your daily credit and debit card sales, plus a fee.
What is a good interest rate for these financing options?
You’ll rarely find that a lender will extend the exact same terms to different borrowers. Every lending situation is different because every business is different.
There are general ranges for financing interest rates, however. Where an offer lands within that range is subject to the lender itself, as well as the borrower and their financial situation and future plans—including the business owner’s credit scores, the time in business, their industry, what they plan to use the financing for, and more.
That said, the typical rates for the above-mentioned business financing possibilities are as follows:
Traditional bank loans: 3-6% APR
SBA loans: 7.5-10%
Equipment financing: 8-30% APR
Business lines of credit: 7-36% APR
Invoice financing: 13-60% APR
Short-term loans: 8.5-80% APR
MCA: 40-150% APR
If you’re in the market for a business line of credit or are considering invoice financing to help even out your cash flow, or need a term loan to help fund a new renovation or expansion, see if the APR your lender quotes falls within these ranges.
Have you received an offer at the lower end of these ranges? If so, you’ve likely got a good interest rate. If you’re getting offers on the higher end, it’s time to start investigating how you can improve your standing in the eyes of lenders.
Why you should look for the APR, not interest rate
You’ll notice that the rates listed earlier are quoted in APR, or annual percentage rate, rather than interest rate.
APR is a more holistic view of what a loan or financing will cost. It includes the associated costs of borrowing, including origination fees and closing costs.
Some lenders will promote their product with a low interest rate, but that doesn’t tell the whole story. For example, some merchant cash advances might quote a reasonable interest rate, but their APR will be much higher than what you might get from a loan or line of credit.
For an apples-to-apples comparison of what financing will cost, compare APR to APR.
What fees are included in the APR?
Depending on the lender and the product, there may be just a few or many extra fees tacked on to your financing, which is what makes the interest rate such an incomplete picture of the total cost.
These fees might include:
Application fee: Some lenders may charge a non-refundable application fee that also covers the cost of a credit check.
Guarantee fee: SBA loans come with a guarantee fee that ranges from 0.25% to 3.75% of your loan.
Origination fee: The time and resources it takes to process a loan is sometimes passed on to the borrower in this fee.
Processing fee: This fee for the cost of underwriting your loan and other administrative costs might be in addition to your origination fee.
Additional service fees: Your lender may continue to charge occasional service fees as they maintain your loan, collect payments, offer customer support, and so on.
Many loan products come with these non-negotiable fees. This is what makes using APR as a comparison point so important—you may not get the entire picture otherwise.
Taking on debt in order to finance growth for your small business is always a risk. In order to minimize your risk and boost your chances of success, you’ll need the clearest picture possible of what that debt costs. If the interest rates and APRs quoted to you don’t make sense for your business, explore other options and work on improving your credit profile so you can take out the financing that’s right for you.
