October 31, 2022 | Last Updated on: October 10, 2024
DISCLAIMER: This article was written in 2022 and has not been updated. For more up to date information about small business funding products and options, please browse our recent articles.
To reduce inflation, the Federal Reserve has been raising interest rates at an unprecedented pace. This has made the cost of borrowing, including for business loans, go up dramatically.
After years of historically cheap financing, small business owners are finding it challenging to get loans they can afford.
This article will reveal how to secure business financing with relatively low annual percentage rates (APRs) in 2022 and beyond.
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Despite the recent increase in interest rates for business financing, it is possible for business owners to get relatively affordable funding. Here are some options to consider.
Traditional banks and credit unions typically offer the lowest loan rates. Their most popular financing options are term loans, including long and short-term loans that can be used for working capital, refinancing debt, and other purposes. Funding from these financial institutions typically comes with long repayment terms and large maximum loan amounts. Interest rates average about five percent. That figure changes frequently in today’s economy and can vary significantly depending on the type and purpose of the financing, the creditworthiness of the borrower, and the amount and term of the loan.
The issue with business bank loans is that they usually have the most challenging eligibility requirements, complicated application processes, complex underwriting requirements, and take a relatively long time to get funding, usually weeks to months. (The application usually includes uploading a current business plan, bank statements, tax returns, and other paperwork.) Banks typically require businesses to be in operation for two to three years and have solid finances. Owners must have a personal credit score of 700 or higher to secure low-interest bank financing. Banks and credit unions may also require you to put up collateral to secure the loan, especially if it’s for a significant amount. (Loans for vehicles and business property are usually backed by the vehicle or property they’re used to purchase.)
Tip: A long-standing relationship with a bank or credit union could help you get approved for loans with competitive interest rates and terms. It could also speed up the application process.
SBA loans, like those through the popular SBA 7(a) loan program, are partially guaranteed by the U.S. Small Business Administration. Lenders approved by the SBA offer them. The government guarantee reduces the risk for these lenders, which helps lower their interest rates. SBA loans also have favorable terms. Current SBA loan interest rates start at just over eight percent and go up to almost 13 percent, depending on the type of loan, purpose, and borrower’s creditworthiness.
Based on Small Business Administration guidelines, SBA loan interest rates are based on the market prime rate plus a markup rate known as a spread. That means as the market prime rate rises, SBA loan interest rates also rise. That’s currently happening because of the Federal Reserve’s efforts to combat inflation.
Qualifying for SBA loans is a little easier than bank loans, but you’ll need good credit, solid finances, and several years in business to qualify for financing. If you need fast or same-day funding, SBA loans are not the right option. The SBA loan application and approval process can take anywhere from one to three months. The two exceptions are SBA Express and disaster loans, which can be approved and funded in a few business days.
The Small Business Administration provides answers to frequently asked questions (FAQs) on its website.
Some online lenders offer low-interest business loans, but in most cases, APRs for loans secured through them are higher than those from traditional lenders. The reason is that most online lenders have looser approval standards, and the higher interest rates cover the added risk.
Online lenders can often approve an application and deposit funds into your business bank account or business checking account in as little as one business day. Interest rates for online financing start at just over ten percent and can rise above 30 percent for less-reputable online lenders.
Typically, online lending companies have more flexible requirements than banks or SBA lenders. However, to qualify for the best rates and terms from online sources of financing, you must be the owner of an established business with solid finances. Your personal and business credit scores must be excellent.
Be aware: There are online lenders willing to work with startups and new businesses or those with poor credit or a history of bankruptcies. Be aware that you may pay interest rates on loans from them that could rise to 99 percent. They also come with short terms and significant hidden fees and penalties. If you’re an entrepreneur starting a company or have a bad credit score, compare several different financing options and think carefully about how much debt you can realistically afford and whether you can make the monthly payments.
Community-based nonprofits and microlenders make it their mission to provide low-interest microloans to small businesses in their communities. Loan amounts are usually small. They typically cap out at $25,000. Interest rates may be higher than bank or SBA-backed financing, but these lenders can be a good option if you can’t qualify for those types of funding.
Nonprofits and microlenders loan money to traditionally underserved businesses, including women- and minority-owned companies and those in low-income or disadvantaged neighborhoods. Some organizations focus their lending efforts on startups or businesses whose owners have bad credit (a score below 630) or limited credit history. The application process for these loans is relatively easy, but it can take a significant amount of time to get approved and funded.
These three types of loans often come with relatively low APRs because the equipment, vehicle, or business property they’re used to purchase back them. That means the lending company can take the items or property if you don’t make the required payments. Equipment, vehicle, and property loans are attractive because you usually don’t have to put up business or personal collateral or make a personal guarantee to qualify for them. The only negative related to these types of financing is that you may need to make a down payment on your purchase before you qualify for financing.
The lowest-interest small business financing option is a grant. Grants are provided to companies for various purposes, and they never have to be paid back, making them essentially no interest funding. Organizations that offer grants include government agencies, small-business chambers of commerce, and pro-small-business private foundations.
Be aware: Grants are a very attractive small business funding option. However, applying for them can be time-consuming, and competition is fierce.
You may be able to get a low- or no-interest loan from a family member, friend, or customer. These loans can be risky because they can destroy relationships if the money isn’t paid back. If someone offers you personal financing, make sure you put the repayment terms in writing and do everything possible to meet them.
Equity financing could make sense for your business. In short, you sell a portion of your company to an investor and pay them a percentage of your profits regularly in proportion to the share of your business they own.
Be aware: Equity financing can be a relatively inexpensive way to fund a business. However, you will lose control over a part of your operation.
Credit cards often come with relatively low interest rates. However, they’re not appropriate for longer-term business funding needs. Instead, they’re effective for paying everyday business needs and tracking expenses for tax purposes.
Similar to business credit cards, lines of credit are a revolving form of funding. That means you receive a defined amount of money you can borrow against, not a lump sum payment, and you only need to pay it back when you use the funds. Also similar to credit cards, credit lines are suitable for smaller expenses, such as emergency or seasonal cash flow needs.
Be aware: Other types of business financing, like merchant cash advances and invoice factoring, come with relatively high interest rates and costs even in less challenging economic times.
Here are some steps you can take to get approved for low-interest financing during these challenging times.
You’ll need to meet strict eligibility criteria to qualify for loans with lower interest rates. These include:
Specific business loan requirements will vary based on the lender and loan type. If you can’t meet these requirements now, take steps so you can in the future.
Take time to look into different funding types. Work with the lenders that make the most sense for your funding needs and situation. For instance, if your credit score is low, it probably makes sense to avoid lenders with strict financing standards like banks and credit unions. Instead, focus on online and alternative loan companies.
Always get multiple loan offers from different lenders to ensure you get the best deal for your business. Compare the business loan interest rates using the annual percentage rate, or APR. This number includes your interest rate and additional loan fees, such as origination fees and prepayment penalties.
Not all lenders communicate their borrowing costs as an APR. Some may use a simple interest rate or a factor rate. In this case, you’ll want to calculate the rate into an APR by adding in the fees so that you can better understand how much different loans cost, and you can make an apples-to-apples comparison of them.
In the end, the best small business loan is typically the one with the lowest rates and best terms that meets your specific business needs. But other factors like fees, the reputation of the lender, and the service it provides should be considered. Paying a little bit more in interest could be worth it if your experience with your lender is a good one.
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