When approving loans for a business, lenders not only offer a set monetary amount, they also determine an appropriate business loan rate. If you own several marketing companies in Los Angeles and have years of success under your belt, your business loan rate will be much lower than a startup company that has very little track record. But why?
Lenders look at several factors when determining business loan interest rates for applicants. These factors determine the overall risk of you defaulting on the loan. The higher the risk, the higher your interest rate will be. Higher interest rates give lenders even more protection in the event that you don’t pay your loan.
Here’s everything you need to know about how lenders determine your business loan rate.
Credit Rating
When a lender considers your business loan application, one of the first factors they consider is your credit rating, which includes your credit score and credit history. When looking at your credit score, lenders want to see a number above 550. This means that both your personal and business credit should be in good standing.
Credit history is also important. Lenders want to see that you aren’t carrying a high amount of debt. Lenders also want to see a credit history that indicates that:
- You make payments on time
- You pay more than the minimum payment
- There are no liens or past-due reports
The better off your credit standing is, the lower your interest rate is likely to be. If your credit history is less than stellar, consider applying through a lender that doesn’t require a credit check. You could also consider waiting before applying for a business loan. This gives you time to pay down debt and to give your credit score a boost.
Cash Flow
Lenders want the assurance that you bring in enough cash flow in order to make your loan payments. To do this, lenders examine your financial and bank account statements to see how much money you’re bringing in as well as what those funds are used for. When looking at these documents, lenders want to see a consistent amount of cash flow. While peaks in income won’t impact your application, periods where cash flow fell below your monthly average may be a red flag.
If your business doesn’t have a consistent amount of cash flow, getting approved for a business loan will be hard. Positive cash flow is the lender’s only assurance that you can afford to make your loan payments. Without proof that your company is bringing in income, you’re seen as an extremely risky borrower. Of course, if you’re a startup or a new business, showing periods of positive cash flow is nearly impossible. It takes time to get your business up and running and generating income.
For startups and new businesses, going the traditional lending route may not be your best bet. Consider alternative business lending possibilities such as online lenders, crowd-funding, or even working with an angel investor.
Collateral
Another way to offset the risk of lending money to a business is to put collateral against the loan. Collateral includes property that backs the value of the loan. In the event that a borrower defaults, the lender can sell the collateral to collect their lost funds. The more collateral you have, the lower your interest rate will be.
The type of business loan you apply for will drive the type of collateral that can be used. If you’re a new business, deposits can be used as collateral. Home equity and other personal property are also acceptable. Other forms of collateral include:
- Equipment
- Inventory
- Real estate
If you’re a considered a high-risk borrower, lenders may not only offer a higher interest rate, you will also be expected to have more collateral to back the loan.
Time in Business
Companies that have been operating for less than two years are considered to be start-ups. If you find a lender that offers you a loan, expect to have a high APR to make up for the added risk. For most traditional lenders, newer businesses aren’t eligible for lending because they are extremely risky. The same stands for small companies.
Lenders want to minimize risk as much as possible so that they avoid the dangers of having a borrower default on the loan. Startups are extremely vulnerable because the risk of a lack of cash flow which in turn means no funding to pay business loan payments.
If you’re a startup looking for a business loan, consider the alternative lending market. Here, businesses with at least three months of operations are eligible for funding.
Conclusion
When applying for business funding, it helps to know which factors may impact your business loan rate. In turn, you can make better borrowing decisions and have an upfront understanding of what type of interest rate you will face.