How Are Interest Rates Determined on Business Loans?

by Finance 23 October 2018

Business Loans

Every business needs some form of investment prior to trading. While investing hard-earned liquidity is not a good idea, a business loan is, on the other hand, a convenient option.

However, there are several aspects which need consideration before opting for such loans. Arguably, the most important pointer to consider is the business loan interest rate. Different lenders have their pre-determined rates of interests based on varied but inter-connected factors. A proper understanding of these factors before availing the business loan is vital.

Type of business:

Lenders initiate the application process by assessing the credit risk based on the kind of business. Therefore, borrowing institutions approve loans to a company with a better credit report than those with a negative one.

For instance, a web developing startup will be considered riskier than an established garment trader. Hence, the business loan interest rate tends to be a bit higher for the former one in comparison to the latter.

Credit history is also significant:

In India, credit score plays a pivotal role in determining the interest rate for business loans. Lenders determine the borrower’s financial position based on the rating given by CRISIL (Credit Rating Information Services of India Limited).

So, if a borrower has established a decent credit score, it gives a chance to negotiate a lower interest rate with the lenders. It is usually recommended for businesses to have a credit score of above 700 for approvals with feasible interest rates.

Inflation and deflation:

Inflation (or deflation) is a microeconomic concept that closely links in calculating the interest rate. With inflation, there is an increase in prices of any product/service and a decline in the value of currencies.

Thus, this decline in the value of rupee increases the interest rate on loans. Therefore, lenders provide the credit at a higher interest rate. In the case of deflation, the exact opposite happens.

Note: To apply for a business loan, a borrower can closely monitor the fluctuations in the inflation rate to get an affordable rate of interest.

Demand and supply of credit:

The interest rate also depends on the ‘demand for and supply of credit’. So, with higher demand for business finance, lenders will levy a higher rate of interest.

Lenders tend to cut down the interest rate when the supply of credit exceeds its demand. Therefore, businessmen can smoothly lower the total actuation of the loan when the demand for credit is low or supply of credit is more.

Business experience:

A borrower can apply for business loans to initiate or expand his business. Usually, lenders tend to charge a slightly higher rate of interest for start-ups due to proportionally higher chances of loan defaults or non-payments.

However, a borrower can get an affordable interest rate, if he has built a successful business experience of at least 3 years.

Annual turnover:

The annual turnover of a company plays a role in actuating the final interest of a loan. Lending institutions compare between the applied business loan amount and the revenue of the concerned enterprise while determining the business loan interest rate.

A borrower can comfortably negotiate for a lower interest rate if his business has a higher turnover. Moreover, higher turnover also aids in getting more credit required for his business.

Type of loan:

Business loans are available both in secured and unsecured forms. Generally, unsecured business loans come with a higher rate of interest compared to the secured ones; lending money, at times, involves the risk of default and non-payment. Collateral can help the debtor fetch a lower rate of interest, but in case of a default or non-payment, the lender can confiscate the collateral to settle the outstanding.

Relationship with the lender:

Lastly, having a cordial relationship with the financial institution also counts while deciding the interest rate. If a debtor is not a first-time borrower and has been able to repay the previous loans in time, lenders build in a sense of trust.

Thus, the borrower can have a lower interest rate on the applied loan amount. Thanks to NBFCs like Bajaj Finserv that provide the applicants with a competitive business loan interest rate. So, next time you plan to apply for a business loan, make sure you consider these points mentioned above to get the best deal as per your requirement.

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Ariana Smith is a blogger who loves to write about anything that is related to business and marketing, She also has interest in entrepreneurship & Digital marketing world including social media & advertising.

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