The interest rates on business loans differ from one lender to another. A single lender also provides the same business loan product to individual borrowers at different interest rates. There are a number of factors that affect the business loan interest rates. Some of these factors are external, whereas others are internal. A borrower must understand both external and internal factors affecting business interest rate to reduce overall cost of credit.
8 External and Internal Factors Affecting Business Loan Interest Rates
1) Rate of Inflation
Inflation rate increases the prices of products and services. But inflation reduces the value of currencies and purchasing power of people. The decline in value of currencies increases rate of interest on business loans. Hence, lenders provider credit at higher interest rates if the inflation rate is high and vice versa. A borrower must monitor fluctuations in inflation rate to decide the right time to apply for a business loan.
2) Monetary Policy
The Reserve Bank of India (RBI) announces new monetary policies at regular intervals to maintain liquidity and control inflation rate. Sometimes the RBI increases liquidity in the money market by relaxing its monetary policy. The enhanced liquidity reduces interest rate on loans and makes business loans cheaper. On the other hand, the interest rates on business loans increase each time the RBI keeps the key rates unchanged.
3) Demand and Supply of Credit
The business loan interest rate is also impacted by demand for and supply of credit. When the demand for credit increases, lenders charge higher interest rates. But the lenders reduce interest rates when the supply of credit exceeds the demand for credit. An entrepreneur can easily reduce the total cost of credit by applying for a business loan when the demand for credit is low or supply of credit is high.
4) Type of Business Loan
Both banks and non-banking financial companies (NBFCs) basically provide two types of business loans – secured and unsecured. A borrower has to keep his assets as collateral to avail a secured business loan. On the other hand, he can avail an unsecured business loan without any collateral. The lenders charge lower interest rate on secured business loans than unsecured business loans. The additional interest rate helps the lender to cover risk of loan default or non-payment.
5) Personal Credit Score
While processing a business loan application, lenders use borrower’s credit history and credit score at the main criteria to assess the credit risk. They assess the financial position of a business based on the rating assigned by the Credit Rating Information Services of India Limited (CRISIL) as well as the borrower’s personal credit score. A higher credit score depict the borrower’s ability to repay the business loan fully and timely. The lenders provide business loans at lower interest rates when the borrower’s credit score is high. But they charge higher interest rates if the borrower’s credit score is low to cover the credit risk. Business owners should read more on how can their personal credit score impact the business.
6) Type of Business
While processing business loans, lenders assess credit risk based on the type of business. They consider certain businesses to be riskier than others. The even charge higher interest rate on business loans to cover the business risk. Some lenders even provide credit at a much higher interest rate to the borrowers from riskier sectors.
7) Business Experience
Most lenders provide business loans for both inception and growth of business. Hence, an entrepreneur can apply for a business loan to raise finance for starting a new business or expanding his existing business. Normally, lenders charge higher interest rate on start-up loans due to chances of default or non-payment. But they provide business loans at a lower interest rate to entrepreneurs for business expansion. Also, an entrepreneur, who has been in the same business for several years, has option to choose from several business loan products.
8) Annual Turnover
Lenders always determine the business loan amount based on the business’s turnover. They determine interest rate by comparing the business’s revenue with the amount of business loan to determine. Hence, a higher turnover depicts that the borrower’s financial position is positive. A borrower can easily negotiate with the lender for lower interest rates if his business has a higher turnover. The higher turnover will further enable the borrower to raise more credit and avail flexible repayment options.
On the whole, business loan interest rates are affected by both internal and external factors. The borrowers must analyze these key factors affecting business interest rate to reduce the total cost of credit.