<strong>How Lenders set Interest Rates in Business loans</strong>

How Lenders set Interest Rates in Business loans

 Business loans are important to entrepreneurs since they help them expand and sustain their businesses.

 Business loans are important to entrepreneurs since they help them expand and sustain their businesses. Yet, this necessity is more important for small business owners who may not have sufficient capital to drive their business agendas. 

Moreover, most business loans are offered to merchants at different interest rates. Because banks normally use a specific benchmark to determine the prime interest rate for a proposed business loan. At the same time, the business owner’s creditworthiness determines this benchmark.

Here are some factors that determine interest rates on a business loan.

Creditworthiness 

This factor greatly influences the likeliness of acquiring a business loan and the loan’s interest rates. A borrower’s creditworthiness is determined by some considerations, which, if combined, will lower the lender’s risk of loss from non-payment.

The amount of debt determines creditworthiness through borrowers’ income ratio and borrowers’ total payment history of all expenses, including loans.

Traditional banks, however, will still follow a rigid route to establishing a credit history and may require collateral before issuing a loan. Yet emerging lenders are providing lending alternatives, with most of them incorporating technology-based ways of determining creditworthiness and issuing business loans without necessarily needing property guarantees.

Individual and Macro Factors

Apart from creditworthiness, accessing business loans may be determined by various macro factors, including:

  1. Geographical environment: Is your business located in an area that may experience a customer shortage or environmental and political instabilities.
  2. Local infrastructure: Does the place where your business is located enjoy good infrastructures such as electricity, roads, and other important necessities for sustaining a favorable business environment.
  3. Economic Sector of business: Is the economic sector sufficient for full-time business or offers a more seasonal business environment.

This factor influences the interest rate for most lenders, but the scale at which these macro factors affect the interest rate differs from lender to lender.

Technological Risk Assessment

Lenders started to incorporate tech-led methods of determining creditworthiness. This assessment model is helpful to merchants, mostly new borrowers, by lenders implementing available data points to come up with a unique rating scorecard.

Fintech companies always depend on their data point-driven determination to issue loans. This technique covers more borrowers and businesses in the credit scheme. However, the ability of lenders to confidently provide loans through credit risk assessment models entirely depends on their tech support and advancements.

Therefore, a clear combination of technological risk assessment processes such as e-wallet payment options, Video-KYC, and electronic disbursements will provide businesses with credit securely and faster.

When lenders improve the ease and efficiency of their risk assessment process, they can issue loans to a wider range of borrowers.

Micro factors

Other smaller factors that also determine the interest rate and loan tenure also include:

  • Status of other existing loans
  •  your business’s actual profitability and cash flow 
  • the personal net income of the merchant
  • How long has the business been operational

Winding-up

For the more established enterprises, merchants may opt for a secured loan that is guaranteed against the business’s property, which will allow lower interest rates. This secured loan is a much more feasible option, especially if the merchant is a first-time borrower.

Author bioMichael Hollis is a Detroit native who has helped hundreds of business owners with their Business Loan solutions. He’s experimented with various occupations: computer programming, dog-training, accounting… But his favorite is the one he’s now doing — providing business funding for hard-working business owners across the country.