Understanding Business Loan Interest Rates
Almost every business loan comes with interest - it’s one of the key costs to consider when taking out a loan. But it can be difficult to know when you’re getting a good deal on your business loan interest rate.
Your interest rate is how much it costs to borrow from a lender. Your interest will be calculated differently based on what type of product you have and your arrangement with your lender.
What is the average rate of a business loan in the UK in 2024? What affects this rate, and what can you do get the best interest rate possible? At Clifton Private Finance, we can help answer these questions.
Understanding the Bank of England Base Rate
The last year has seen a great amount of uncertainty regarding interest rates and inflation. After 14 consecutive increases between 2021 – 2023, the Bank of England’s base rate had a huge impact on business loan interest rates.
Having some awareness of this core rate is essential to understanding the loan rate you will be able to secure for your business.
When interest rates are low, borrowing is cheap. This entices businesses to take on credit to invest and expand. Both businesses and consumers spend more, which in turn increases the market value of goods and services.
This leads to rising inflation and a situation where those smaller businesses without access to larger funds can struggle.
Conversely, when interest rates are high, borrowing is an expensive undertaking. Businesses become more financially cautious and the market has to pull back on raising prices. Inflation slows and the market can become stagnant.
The Bank of England set their base rate to try to control these and other factors. It is the rate they charge banks and other lenders to borrow money and has a knock-on effect with the interest rates those banks and lenders charge borrowers.
Of all factors, the Bank of England base rate is perhaps the most significant when it comes to understanding your end business loan interest rate.
Inflation began to rise drastically, reaching its peak of 11% in 2022, a stark increase from 0.89% in 2020.
The Bank of England began to lift the base rate in 2022 and continued into 2023, causing the interest rates for business loans and other types of finance to rise with it.
To get an idea of how business loans for limited companies work and see how their eligibility is calculated, watch our short video below:
Read blog: Business Loan Eligibility - 9 Things to Know
Lender Risk vs. Profit
Lending money is a business like any other. They make a profit through the interest rate on your loan, with higher interest rates providing a higher return for the lender.
Every loan is a business transaction with profit at its heart, and, like every business transaction, there is a measure of balancing risk against reward.
If your loan is considered higher risk, some lenders may turn you down, unwilling to take on that risk. Those who are willing to consider your application are likely to charge you higher interest rates to offset the risk on their part.
Related blog: Getting a Business Loan - 8 Top Tips
There are many aspects of this risk, and all of them will have an effect:
Your business’s creditworthiness is an indicator of how reliable you have shown yourself to be in terms of repayments and fiscal responsibility, and many lenders will use it in their assessments.
Businesses with poor credit are typically viewed as higher risk by lenders. Here, the lender can make a simple adjustment to the interest rate, raising it for businesses with bad credit and lowering it to be competitive for businesses with good credit scores.
Type of Business
A business’s sector will tell the lender a substantial amount about the risk involved. Some businesses in industries such as hospitality, agriculture, and even travel can be seen as high risk by lenders, due to low profit margins and fluctuating income. Some lower-risk sectors include childcare, human resources, and supermarkets.
Lenders will use your business sector as a guideline for the overall viability of your business and, consequently, its level of risk to determine what interest rate will be available to you.
See similar: How Do Business Loans Work?
Loan Purpose and Business Plan
A third factor will be your proposed use for the capital. A business loan that is to prop up a dying business, for example, is of significantly greater risk than one that is earmarked to expand a strong business looking to grow in an established marketplace.
Your business plan is a key document to help mitigate this risk to your bank. A strong business plan will outline your venture and provide the answers to the questions a loan assessor might have. You have the space with your business plan to prove to someone else just how viable and low-risk your idea is, so make sure you use that space.
A weak business plan in an untested business use space is going to put off many prospective lenders, leading you in a similar situation to a business with poor credit, trying to get what you can from a limited pool of lenders, each increasing their interest rates to mitigate the risk.
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A secured business loan is a financial product where the borrower pledges assets as collateral to secure the loan. The collateral serves as a form of security for the lender, assuring that if the borrower is unable to repay the loan, the lender can seize and sell the collateral to recover some or all of the outstanding debt.
This may sound intimidating, but it's a common practice in the world of borrowing. In fact, mortgages are long-term secured loans. Securing a loan helps mitigate risk on the lender's behalf, which can typically keep interest rates down.
Conversely, an unsecured loan is a loan which doesn't require collateral. On the plus side, this means you don't have to pledge any assets to secure the loan, which can be helpful if you only need a small loan.
But if you are looking to borrow substantial funding, an unsecured business loan will be considered higher risk and will typically have a higher interest rate than a secured loan.
Fixed vs. Variable Rate
Business loans can be fixed or variable rates, which plays a significant role in how your interest rate is structured and calculated.
A fixed-rate, as its name suggests, is set in place for a specific period of time; either a few years or for the full length of your loan. In these circumstances, market forces will not change the rate, and you can budget your repayments accordingly. Fixed rates tend to be slightly higher than current variable rates to reflect this additional security.
A variable rate is tied to the overall market, which may change each month to represent wider economic events. This means your interest may go both up and down depending on the current market.
Whether a fixed or variable rate is a suitable option for you depends on the length of your loan term, the economic environment, and your business's income.
For instance, a fixed-rate business loan with relatively high interest rates may not be appropriate if interest rates are predicted to drop significantly during your loan term.
However, if your business has small profit margins, you may be more willing to pay extra to ensure that your interest rates won't surge if the market changes.
It should be noted that fixed-rate loans will become variable-rate loans after the fixed period expires. For example, a ten-year loan with a three-year fixed rate will become a variable-rate loan after the third year.
It is usually possible to refinance your business loan when the fixed rate period comes to an end, taking advantage of an additional fixed rate term.
The interest rate isn’t the only way a lender will make money on their loan. Many business loans will come with additional fees, from setup fees to cover administrative costs in assessing your loan to early repayment fees should you wish to pay off your loan early. Other loans may have no associated interest rate but rely on a single fee to profit the lender.
When looking at the overall cost of a loan to your business, it's essential to understand any associated fees and factor them in as comprehensively as the interest.
The Average Rate of a Business Loan
So, what is the average interest rate of a business loan? As can be seen, it is impossible to say without analysing your business and the overall market. It’s also important to understand that the rate advertised on a loan may not be the rate of your final offer.
The representative APR is the interest rate that more than half (at least 51%) of applicants will receive, but it is not a guarantee of the rate your business will be given once everything has been assessed.
Summary of Business Loan Interest Rate Factors
In conclusion, the following are the most significant factors that will affect the interest rate of your business loan:
- The overall economy, represented by the Bank of England base rate
- Your business credit history and overall creditworthiness
- Your business sector
- The purpose of the loan
- Your business plan and financial forecast
- Whether collateral is used to secure the loan (and the type of collateral)
- Your chosen lender and their product range
How We Can Help
At Clifton Private Finance, we have a team of dedicated finance and loan specialists to find the perfect loan to suit your business needs. Our advisors will examine the entire market and walk you through the options available to you to get the best interest rates and lowest fees - as well as a loan type that suits your requirements.