What Determines the Interest Rate on your Small Business Loan

I was speaking to my banker friend Christopher awhile ago and I asked him what is the first question you hear a lot when working with small business?  He told me that the question that comes up alot is “What is the interest rate?”.   As we talked, Christopher told me that there are many factors that go into this and he will explained them to me.

Personal Credit Score:  Part of the overall process that lenders will weigh heavily on, since your personal credit score is a measure of your reliability in paying back your financial obligations.  The lower the FICO (at most finance companies they do a SOFT credit pull (ask your banker), the riskier the loan could be in the eyes of the lenders.

Business Industry:  Clearly some industries are deemed riskier than others and could have a harder time paying back their obligations.  Some groups like the The Innovative Lending Platform Association (ILPA) is a leading trade organization representing a diverse group of online lending and service companies serving small businesses.   When you visit the site, you’ll find some of partners in the association each work with 80+ lenders that have helped originate loans in every type of business, with some being more difficult.  I’m told that hard to fund loans may be Adult Entertainment, Firearms, and Real Estate Investing.  If loans are approved in those industries, the rates may be higher.

Time In Business:  Businesses under the 6 month TIB (as registered in your states Secretary of State website) are considered startup business and extremely difficult to fund.  The ability of lenders to extend offers for those businesses that have TIB  of more than 1 year is greater.  The shorter the TIB, the higher the cost of the loan since there is a greater risk with the merchant.

Monthly Revenues:  When assessing your business, they look at what your business has been doing over the last 3 months.  Businesses that show consistent or improving revenues and multiple deposits are looked at more favorably (and thus get better offers) than those with just a couple of deposits a month and fluctuating revenue.  Lenders like stability or an increasing business to extend better terms.

Existing Debt:  The “Kiss of Death” with regards to offers.  When they talk to you, they look to see that your existing cost of financing doesn’t exceed 20%.  If your current loans are at that level or higher, the chances of getting an affordable offer are slim.  Their goal is to try and make sure that your cost of debt doesn’t exceed more than 15% of your revenues.

What Type of Loan: In June 2016, the three largest online small business lending platforms and a leading national non-profit microfinance trade association joined forces with other leaders in the space to create an industry-first model pricing disclosure focused on empowering small businesses to more fully understand and assess their small business finance options.  The result of this effort was the development of the SMART Box™ – which stands for “Straightforward Metrics Around Rate and Total cost” – a comparison tool intended to foster common verbiage and enhanced disclosure standards around a comprehensive set of pricing metrics.  The SMART Box includes clear and consistent pricing metrics, metric calculations, and metric explanations to help small businesses understand and assess the costs of their small business finance options.

So now that you know the rules of the game, where is your business?  If you are looking strong in all of these categories, the types and cost of financing for your business is greater than if just a couple of these are good.