Business Loan: 7 game-changing factors that determine your interest rate

Funding is one of the biggest requirements for most businesses to survive or sustain. Funding can come from equity, debt, or other sources. Many organisations rely on business loans for their various needs. Lenders consider several parameters to decide whether the business is eligible for a loan and what should be the interest rate charged. Let us look at some factors lenders consider to determine the interest rate on business loans.

Factors considered for determining the interest rate on business loans:

Credit score

Banks and NBFCs use the credit score to determine the borrower's creditworthiness. Based on the credit score, they decide whether the loan should be given and at what interest rate. A credit score of 750 and above is considered healthy for a loan. The higher the credit score, the better. If the credit score is higher than a specified number, some banks may offer a loan at a lower interest rate and better terms.

The bank may consider a low credit score as a sign of poor credit history. Such profiles are considered risky. The bank may either decline the loan proposal or insist on collateral or offer the loan at a higher interest rate.

To improve your credit score, always pay all loan EMIs and credit card bills on time. Apart from timely repayments, maintain a credit utilisation ratio of 30% or lower, maintain a healthy mix of secured and unsecured credit, don’t apply for a loan with multiple banks/NBFCs simultaneously or within a short duration, etc.

Availability of collateral

The security against which the loan is availed is known as collateral. If your business loan is secured with collateral, the interest rate charged will be lower than an unsecured loan. The security offered can be related to your business, such as machinery, stock, etc., or personal, such as your residential property, etc.

Type of business loan

The type of loan influences the interest rate. For example, a secured loan is offered at a lower interest rate, and an unsecured loan is offered at a higher interest rate. Similarly, whether the business loan comes under priority sector lending or not influences the interest rate. For example, business loans related to agriculture, MSMEs, education, housing, social infrastructure, renewable energy, etc., come under priority sector lending.

Banks have targets for priority sector lending. Hence, if your business comes under priority sector lending, your business loan may get some preference and may come at a lower interest rate than other business loans.

Another important consideration in the business loan interest rate is the type of loan: fixed or floating. In a fixed-interest rate loan, the EMI stays constant. A floating interest rate is linked to a benchmark like the repo rate. As the repo rate changes, the interest rate on the loan will be revised. A fixed-rate business loan comes at a higher interest rate than a floating interest rate business loan.

Inflation and market interest rates

The current economic environment plays an important role in determining the market interest rates and, thereby, the interest rate on your loan. In a high inflation period, the market interest rates will be high, and hence, the interest rate on your business loan will be high.

Similarly, in a low inflation period, the market interest rates will be low. Hence, you may get a business loan at a low interest rate.

Business nature and history

The bank will check the nature of the business to see if it is seasonal or speculative. Such businesses are considered riskier than others. Business loans to such firms come at a higher interest rate than others.

The business history, i.e., the number of years it has existed, also plays an important role. The longer the business has existed, the more the number of business cycles it has survived. The long history of existence shows the business is resilient and can survive adverse economic conditions.

Business financials

The bank will analyse the business financials to determine the loan eligibility and interest rate. They will check the business balance sheet (assets and liabilities), profit and loss account, margins, cash flows, etc. If the business is profitable and generates healthy cash flows, the probability of getting a loan at a lower interest rate increases. The bank will also check the existing leverage, i.e. existing loans, and how much more leverage the business can handle.

Future business plan

Along with the loan application, the bank may ask you to submit a business plan. The plan should have details like the purpose of the loan, the revenue and margin targets, the expected cash flows, etc. Make sure the business plan is robust.

Existing relationship with the lender

Do you have an existing relationship with the lender in the form of current accounts, deposits, or loans? If yes, the lender may give you the benefit of the existing relationship by offering a business loan at a lower interest rate than other borrowers.

Business loan interest rate: Business-related and external factors matter

Business-related and external factors influence the business loan interest rate. You have no control over external factors like the current economic environment. If inflation is high, the interest rates will be higher. However, business-related factors like credit score, collateral, loan tenure, business financials, etc., are in your control. You can work on these factors and put your best foot forward to get a business loan at the lowest possible rate.

How to get the best interest rate for your business loan?

When applying for a business loan, it is recommended that you compare the interest rate and loan features of various banks and NBFCs. You can do this online. Based on this comparison, you can shortlist 2-3 banks/NBFCs. You can meet their executives and take the discussion forward. You can then compare the loan offers from these banks/NBFCs and choose the one that suits your business requirements.

Gopal Gidwani is a freelance personal finance content writer with 15+ years of experience. He can be reached at LinkedIn.