Disclaimer: Information in the business line of credit articles is provided for general information only, does not constitute financial advice, and does not necessarily describe Biz2Credit commercial financing products. In fact, information in the business line of credit articles often covers financial products that Biz2Credit does not currently offer.

Small business owners can leverage various financing options to raise capital to help them expand, tap into a line of credit when needed, purchase equipment, purchase inventory, hire or retain talent, acquire another business, and more. One of the most common types of business financing is a business line of credit.

When you get a business line of credit, you’ll pay interest whenever you draw money from the credit line. Usually, you’ll pay a fixed interest rate on each draw, but depending on your situation, variable interest rates may be worth exploring. Whether you’re looking for variable interest rates on a business line of credit or a term loan, business loan interest rates change quickly, and it’s important to understand what you’re signing up for.

In this article:

• What is a variable interest rate?
• The pros and cons of variable interest rates
• How variable interest rates work on different types of financing.

Interest rates on business lines of credit

According to the 2024 Small Business Lending Survey, in Q2 of 2024, the average fixed interest rates for a new line of credit ranged between 7.7% and 8.2%, while variable interest rates ranged between 9.0% and 9.2%.

It’s important to note that these are averages. The actual interest rates on a business line of credit depend on creditworthiness, business revenue, time in business, the loan term, and more factors. With good credit, you may get a better rate, while bad credit may lead to a worse rate.

Business lines of credit tend to have shorter repayment terms than term loans, which means that variable interest rates may change monthly or quarterly rather than every few years. As such, it’s vital that entrepreneurs understand how variable interest rates work so they aren’t blindsided when drawing credit suddenly becomes more expensive.

What is a variable interest rate?

When taking out a loan for your small business, understanding the business loan interest rate is critical because it directly impacts your repayment amount. Interest on a loan payment is the fee for borrowing money. When you borrow money from a lender, you don’t just pay back the principal, but the principal plus interest.

There are two types of interest rates we focus on in this article: fixed and variable.

As their names suggest, a fixed rate remains the same for the loan's lifetime, while a variable rate adjusts at certain intervals based on an underlying benchmark interest rate or index.

There are many types of small business loans depending on your business needs, and the underlying benchmark interest rate or index for a variable interest rate depends on the type of loan, the loan amount, the time it takes to repay the loan, and more factors. It is often associated with the London Inter-Bank Offered Rate (LIBOR) in the United Kingdom or the federal funds rate in the United States.

The average interest rates on business lines of credit and business credit cards tend to be higher than on long-term loans. When working with any lender, you can see how your variable interest rate will work during the loan application process.

Pros of variable interest rates

Whether you’re exploring business credit line rates or term loan rates, consider these pros when gauging variable interest rates:

• Monthly payment may drop: A variable interest rate adjusts based on an underlying benchmark interest rate or index. If the benchmark interest rate or index declines, so does the interest payment, which will reduce your monthly loan payments. An interest rate on a business line of credit can occasionally be quite competitive.
• Typically start with a lower rate: Variable interest rates typically have a lower starting point than fixed-rate loans. With a variable interest rate loan, the initial interest rate can be locked in for a period of time at the beginning of the loan. With a fixed rate, borrowers are paying a premium to have a predictable payment throughout the loan. At least initially, your payments with a variable rate will be lower than if you went with a fixed rate.

Cons of variable interest rates

On the other hand, there are also some cons to variable interest rates:

• Monthly payment can go up: If the benchmark interest rate or index rises, the interest payment will increase your monthly loan payment. It is possible that the variable interest rates can go up to the point where the borrower may have difficulty paying the loan. Higher interest rates can cause significant problems.
• Unpredictable: The fluctuations of variable interest rates make it harder to predict future cash flows. This can create issues for business operations and impact personal stress levels. Many businesses need clear, predictable cash flow to operate the business. However, there are tactics we explore below to help offset the unpredictability of variable interest rate loans.

How a variable interest rate works

To illustrate a variable interest rate in the real world, let’s take a look at an example.

Suppose a small business owner is considering taking out a 7(A) loan from the U.S. Small Business Administration (SBA). When looking to secure an SBA loan from a small business lender, you might be offered a loan within the following interest rate range depending on your credit history, personal finances, the loan amount, and duration of the loan repayment:

• SBA 7(a) (variable rates) 7% – 9.5%
• SBA 7(a) (fixed rates) 9.75% – 12.75%

Note the ranges of the variable rates vs fixed rates. As noted above, you will likely start with a much lower interest rate with a variable rate loan.

Typically, the variable rate will be locked for an initial period of time, and then reset according to present benchmarks every 3 months to one year of the loan period.

The SBA has established interest-rate guidelines for lenders for their loan programs to keep small-business borrowing costs as low as possible for small business owners.

Interest rates for SBA 7(a) loans are set based on the daily prime rate, which adjusts based on actions taken by the Federal Reserve, plus a lender spread. The lender spread is negotiated between the borrower and the lender and determines whether a fixed or variable interest rate loan is best. The SBA has controls in place so the maximum spread lenders can charge based on the size and maturity of the loan does not get out of control.

A lender providing an SBA loan may also calculate interest rates using the one-month London Interbank Offered Rate plus 3% or the SBA’s optional peg rate instead of the daily prime rate. Which benchmark or index your loan is tied to is part of the loan process when the underwriting department determines how much you qualify for.

Working with an online financing platform like Biz2Credit, you have access to funding specialists who can walk you through these details.

Variable Interest Rates on Business Line of Credit vs. Term Loan

Now that you know the basics of how a variable interest rate works, let’s compare how they look in action across two different funding types.

Business Line of Credit

Some of the best business lines of credit offer variable interest rates. Line of credit interest rates are often fixed, but businesses can take advantage of introductory offers from traditional or online lenders, or get a short-term variable line of credit when interest rates are low.

With a business line of credit, you don’t receive a lump sum of money upfront like you would with a loan. Instead, you get a credit limit from which you can draw money when you need it. You’re only charged interest on what you use, not the full credit amount. So, even if interest rates on business line of credit are high, you at least will have more control over when you pay them.

Some companies offer 0% annual percentage rate (APR) and no annual fee introductory offers, but even if you lock in a variable rate, it will likely be lower than a fixed rate line of credit. If you have short-term needs, like financing new equipment or paying for an important ad campaign, you can use the line of credit to pay for your business needs and then pay it off with low interest.

Depending on the loan term, interest rates on business line of credit may increase after a few months or a year. As such, the cost of purchasing with a line of credit will also increase, so it may not make sense to continue doing so. However, unlike a loan, you aren’t locked into a repayment schedule unless you use the credit allotment.

Due to their flexibility and lower eligibility requirements, business lines of credit are better business financing options for startups and entrepreneurs with bad credit. Like a loan, lines of credit rates are subject to credit approval.

Term Loans

Term loans come in all kinds of sizes, from short-term working capital loans to long-term loans for commercial real estate or general business purposes. For this example, we’ll assume a large loan amount and a long repayment term.

Entrepreneurs with a higher risk appetite may opt for a variable interest rate on a large loan balance to lower the monthly payments upfront. Depending on the macroeconomic environment and lender, even a new variable rate may still be lower than the fixed rate. However, any increase on a large loan amount can have serious impacts on your monthly payment.

For instance, the monthly payment on a $1,000,000 loan with a 10-year term and a 7.5% interest rate is $11,870.18. If the interest rate increases to 9%, the monthly payment rises all the way to $12,667.58 — nearly $1,000/month. Unless you’re making significant annual revenue increases, that can be a difficult payment to manage.

Borrowers with stronger creditworthiness will be eligible for more competitive rates, and if your personal credit score remains strong, you could refinance your variable rate loan later to continue getting low rates. But when you do this, you’ll pay new origination fees, maintenance fees, and additional refinancing fees which may offset the savings you gain. All of this makes the higher interest rates on a business line of credit less daunting.

Regardless, with a large term loan, you must take a more active role by reviewing loan products periodically and understanding your eligibility to refinance.

Conclusion

The previous two scenarios demonstrate the hypothetical power of a variable interest rate loan. However, in certain economic environments, a variable interest rate loan can drive up your monthly loan payment. You might find it hard to pay back the loan and possibly default.

For large-balance loans, any adjustments up to your interest rate will impact your monthly payment more than if you have a small-balance loan.

With lower working capital at your disposal, your business may struggle. That’s why a smart hedge is to include a business line of credit in your small business financial plan. Although the average interest rates on business lines of credit are higher, you only pay interest on the amounts you use, giving you greater flexibility. Not to mention, the best lines of credit offer compelling introductory offers. Business lines of credit can be a good option for any type of business.option for any type of business.

FAQs

What is the interest rate on a business line of credit?

According to the 2024 Small Business Lending Survey, in Q2 of 2024, the average fixed interest rates for a new line of credit ranged between 7.7% and 8.2%, while variable interest rates ranged between 9.0% and 9.2%.

That said, interest rates are subject to credit approval and may be higher depending on your personal credit score, business credit score, and other factors. For many business owners, the rates on lines of credit are significantly higher due to the increased Federal Reserve interest rate from 2022-24.

What does the interest rate affect payments on a business line of credit?

With a business line of credit, you only pay interest when you debit the credit line. Any time you make a withdrawal, you’ll have to pay back the withdrawn amount, plus interest. As such, a higher interest rate leads to higher repayment amounts.

Can a line of credit have a variable interest rate?

Yes, a line of credit can have a variable interest rate. Once you take a draw from the line of credit, the interest rate on the amount you have taken can vary based on the Federal Funds rate or another similar interest rate benchmark.

What is the most common interest rate for a business line of credit?

for many business owners, the rates on lines of credit are significantly higher based on creditworthiness and business performance.

Do business lines of credit or term loans have better interest rates?

Business lines of credit tend to have higher interest rates than term loans, but you only pay interest on what you use. With a term loan, you must pay interest on the entire loan principal. As such, if you only draw on the line of credit responsibly, you’ll likely pay less in interest.

All that said, interest rates depend on a borrower’s credit worthiness and the business’s financial health.

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