Financing your small business often involves the long and arduous task of hunting for, comparing, and applying for the right loan. As you journey down this path, making the “right” decision about what type of financing is best for you is often challenging. Among the things you’ll need to consider is the Annual Percentage Rate (APR) for a potential loan.
We all spend a considerable amount of time as consumers, and so when it comes to APRs, we become accustomed to the low, single-digit rates on consumer loans. With mortgage rates hovering around 3-4% and auto loans not too far away, it’s easy to assume that your small business loan will reflect a similar breathe-easy APR.
But you may suffer some “sticker shock” when it comes to the going rates for these loans. Even a small business loan from a bank will fall above that 3-4% mark, often between 5-10% APR, and those are often the hardest to obtain. If you don’t qualify for a bank loan but you have great business credit (above 160 FICO SBSS score), you might qualify for an SBA loan at 6-13% APR. Some online loan rates can peak at 30% while other, less traditional lending opportunities like merchant cash advances, can land you with a triple digit APR.
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With all that in mind, it’s important to have some sort of benchmark for evaluation. The interest rate you’ll be on the hook for includes a variety of factors that are included in the final APR. If you’re a small business looking into loan options, a 15% APR can be considered a good rate, and here’s why.
- Risk Level Associated with a Small Business Loan: Starting your own company can be risky business—over half of new businesses fail within the first 5 years. It shouldn’t come as a surprise that one of the driving forces behind your APR is the risk associated with your business and small businesses in general. The risk associated with the specific industry under which your business operates is taken into account as well, and your business’s industry could influence the price of your loan or disqualify you for a loan all together.
- Net Return to Lender: It shouldn’t be shocking that the expenses (operational costs) and total profit a lender expects make their way into each loan. Typically, it costs lenders the same amount of money to underwrite a large, multi-million dollar loan for a big business as it does to underwrite a $1M or less small business loan. Lenders charge a higher rate for the smaller loans to ensure the loan is profitable.
- Loan Acquisition: Some borrows simply find a bank through word of mouth or long-term familiarity with a bank, but in most cases, the lender you choose will have allocated money towards getting you (and other borrowers) to walk through their door or visit their website. This specifically includes a loan broker fee which could be 10% of the loan amount or more!
Understanding what factors into a loan APR may not bring down the rate, but it can help you make sense of why a small business loan, particularly an alternative loan, is typically much higher than your average consumer loan.
In the end, your best bet at achieving a desirable loan rate is to attain and maintain good credit. This will always help you unlock the best loan rates available. When all is said and done and you’ve done your homework as a borrower, if you find that a 15% APR is on your horizon, you can rest assured that for many in your position, that’s not necessarily a bad place to be.
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