How Shoes and Feet are Like Small Business Loan Interest Rates – One Size Does Not Fit All Financing Strategies.
When you look at the average commercial loan interest rates, equipment finance rates, bridge loan rates, their terms and dollar amounts, it is a lot like looking at shoes and feet.
They are all structured the same way. However, when you look at them carefully, they come in all sizes and shapes.
For this example, let’s consider a corporate loan (also known as capital loans) to be like a foot. Just like you find differences in feet (flat feet, high arches, and bunions.) you have different types of loans (Term, PO Financing, Invoice Factoring, SBA, Merchant Cash Advances and sale-leasebacks).
Now you need shoes. The sheer numbers are staggering. You have shoes for the right foot and the left foot. You have leather, canvas, and suede.
There are shoes for men and shoes for women. Some shoes are flat, and some have high spiky heels. There are sandals, flip flops, sneakers, and oxfords just to name a few.
Let us consider the shoes to be industry types. There is a broad range of variables. Some shoes are brand new and like “startups” they need to be broken in. Usually, these new shoes can be a little risky.
Then you have the tired old shoes that keep muddling along but offer no spark of newness or opportunities for growth or expansion. They are the steady eddies that no one notices, especially the lenders.
Let’s take a close look at sneakers. Why are some so expensive? I can buy a pair of Maison Margiela, Future Destroyed High-Top Sneakers, for $1,425.00 or a pair of Black Kanye West 350 Boost Running Shoes for just a few bucks. What makes one any more special than another?
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What’s for dinner?
In this example, sneakers are the Restaurant industry. Some restaurants serve a tasting menu, and you will pay several hundred dollars per person, or you can just go to McDonald’s for a twenty-nine-cent hamburger.
Moreover, even if we just look at hamburger joints, I bet that you agree that sometimes it is hard to distinguish why one is so much more expensive than another. Is a $1,425 sneaker any better than a good old pair of Converse for $35? I guess it is a matter of taste. Do you agree?
This pricing difference leads to the next questions as to why one hamburger restaurant gets a $50,000 loan, and a similar restaurant by gross revenue only gets $35,000?
Now let’s move on and talk about shoe sizes. Half sizes and small shoes for the tiniest of tots and shoes for giants up to size twenty-six. Different shoe sizes, in this case, represent the dollar amounts of the loans. Like shoes, loan programs, loan size and loan rates can all be different. Just like the Brannock Device to measure your feet, is it no wonder why you need business loan calculators to figure out the proper loan?
Let us address the interest rates. These are like your shoe widths. Some are narrow or low while some are wide or even double wide. You get the point, right?
Lastly, there are a wide variety of shoe stores. Some are specialty shops, and some are the big box department stores and let’s not forget the online sellers. Some are known to charge more while others are extremely competitive. I guess you can say this is like the financial institutions that offer smallbusiness loans. You have your big box banks, while credit unions may be more like the specialty shops and the online lenders that are like the Amazons of the world. As you can imagine, there are tons of resources for small businesses.
All I want is a simple pair of shoes
It is not that simple. There are all sorts of risks when you buy shoes. You do not buy high heels to go mountain climbing. Why? It is obvious. Bad traction and high risk of twisting of breaking your foot.
Boat shoes are great when sailing and even for casual wear, however, matched with a tuxedo on a formal occasion can present some fashion faux pas risks.
STOP! I am just going barefoot!
We have clearly established that you have different kinds and sizes of feet. You have all types of shoes to fit them varying in cost, style width and comfort. Moreover, you have different risks if you do not step carefully.
Back to business loans and interest rates
There are many risk factors and considerations that go into the pricing of small business loans. These are the factors that affect and ultimately determine the cost of funds or the annual interest rates.
These factors assist in determining the loan size, the duration of the loan, even the type of loan.
Like shoes and feet, interest rates vary depending on the industry, loan size, where you are getting the loan from, the amount borrowed, your credit history and more. Loans for bad credit have an average interest rate and monthly payments that will be higher than bank loans or SBA 7a loans.
It is not hard to imagine that commercial truck financing rates are different from equipment loan rates. I do not think you must be a Harvard MBA to understand why farm land loan rates are not the same as commercial auto or truck loan rates.
An invoice factor rate is noticeably different from agricultural or freight factoring loan rates.
Another significant influence on business loan interest rates will be the market. As the markets supply and demand and economy change, so will the annual interest rates.
Small Business Administration SBA or 7a Loans and Short Term Business Loan Rates
The criteria to underwrite short term loans can be so varied that there is no “average” way for establishing the interest rate on these business loans.
What is the Current Interest Rate for Small Business Loans?
One reason is there are no uniform requirements for average business loan rates for things like mezzanine financing rates, commercial lending interest rates, nonbank corporate business loans or even dental practice loan rates.
To make sure you are qualified the minimum criteria for SBA approvals are:
There are five basic criteria to be eligible. There are exceptions, and startups are sometimes approved:
- In business, at least two years
- FICO or personal credit score is 680+ (no bad credit loans)
- Seeking an amount of money or loan amounts of at least $30,000
- Past year revenue at least $50,000
- Business is profitable
This lack of standard rate setting across all nonbank and commercial lenders is entirely different for SBA Loans. In fact, the Small Business Administration 7a loan program sets the sba loan rates that banks and SBA lending institutions can charge on the life of the loan.
The challenge and the reason why business owners must look to these nonbank lenders or alternative lenders are usually the criteria to get approved for the SBA loan or the sheer volume of paperwork in the application process, beside the loan application and time required to get funded, is monumental.
The following breaks down a lot of the information that can help you make educated decisions on securing a business loan and the cost of funds. Being educated ultimately helps you in getting the funds you need to help your business grow.
What are current small business loan interest rates and key factors in SBA interest rates
The SBA loan program looks at the prime rate, LIBOR, and SBA peg rate. The organization reviews loan terms based on whether the loan is for less or greater than seven years.
Loans of seven years show a max interest of half a percentage higher than similarly sized loans of less than seven years.
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Fixed vs. Variable SBA Interest Rates on Business Loans
Interest rates can be variable or fixed. A fixed rate loan means that regardless of what happens to the interest rate market, your interest rate remains constant. You have a set cost of funds that’s predictable.
A loan with variable interest rates can change over the course of the loan. This shift in rates can happen monthly, quarterly or more frequently.
Which type is better?
There is no right or wrong answer. When rates are closer to historic lows, the fixed rate probably makes more sense? Why?
Chances are you locked in a low fixed rate with low monthly payments for a set number of years. Locking in fixed rates enables you to consolidate higher interest rate loans or credit card payments into a more affordable and lower cost payment.
When rates are high (or higher), choosing a fixed rate suggests that you believe that the interest rates will go even higher. If that is your belief, then the fixed rate makes total sense.
When you believe that rates will be dropping, then the variable rate may make more sense. The same logic applies. Why lock yourself into a higher rate when the trend is downward?
The caution here is that if you are wrong, the payments will increase and make the loan more expensive and perhaps putting a strain on your cash flow.
One of three publicly available market rates plus a fixed percentage determines the SBA rate on the variable loans. The rate will always be at or below a maximum interest rate set by the Small Business Administration.
For smaller loans, lenders are likely to offer only variable loans with interest rates close to or at the SBA max allowable number.
For the base rate, banks will choose one of three market interest rate measures: prime rate, LIBOR plus three percent, or the SBA Peg Rate.
The Prime rate is the most popular benchmark. All these rates tend to track one another closely with minor differences between them.
Rates as of April 1, 2017:
Prime Rate: 4% (source: WSJ)
LIBOR (one month) + 3.0%: 3.99% (source: Bankrate)
SBA PEG Rate: 2% (source: National Association of Government Guaranteed Lenders)
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APR or APY
The actual cost of taking out a small business loan includes other interest rates and fees. They are either the annual percentage yield (APY) or the annual percentage rate (APR). These are around 1 percent higher than your loan’s interest rate.
Every loan comes with an origination fee. This cost covers expenses to the lender processing your loan. The cost may not be directly related to hard costs. It can be set arbitrarily by the lender.
The origination fee can be between 4 and 5 percent and is off the top. In other words, a $50,000 loan with a 4 percent fee would have $2,000 taken off the top, meaning the borrower will get $48,000.
The guarantee fee is a cost typically paid by the lender to the SBA. The SBA guarantee “fee” is passed on to the borrower at closing. Guarantee fees are a percentage of the loan size and the term of the loan. Now, the SBA is waiving this fee for loans under $150,000.
“Hidden” Interest Rates
Your APR or APY does not necessarily reflect all loan costs. Business owners will quickly conclude that calculating the actual interest rates on business loans can be tricky if examined in detail. Here’s an example of how borrowing money can be deceptive and the difficulty in determining the rate for small businesses.
A lender can provide a pair of 12-month installment loans of $5,000 to different parties. Both term loans will have the same base rates – 5 percent APR. In one case, by the time the loan is paid off, that instrument will have accumulated $250 in interest.
On the other hand, the second business loan comes with a processing fee of $10 per month and a $100 setup charge. Compared to the loan proceeds of the first business loan, this is an additional $220 monthly.
That brings the maximum interest rate of this loan to a 9 percent APR, almost twice that of the first loan.
If you are not looking closely at the process, you risk not getting a full picture. Make sure you understand the inclusion of all the fees associated with your small business loan.
Lock It In – Small Business Loan Interest Rates Today
As early as possible during the process, see if you can lock in an interest rate. Locking in rates early in the process is a bit of a coin toss as previously mentioned.
If interest rates go down, you will be stuck with the higher rate. However, if rates go up, you will be safe. It is like hoping for the right card at a Vegas poker table, but it is a chance you may want to take.
The Bottom Line
Asking questions is going to be the most critical component when you are looking at business loan interest rates. They are incredibly complex instruments, and if you do not understand them, your business could end up paying hundreds of dollars more than it needs to.
You must know what the loan is going to cost and, more importantly, what it is going to do for your business. I always want to know the return on investment. What’s my break even? What could go wrong? Moreover, what happens if I do not get the money?
Higher credit scores mean lower interest rates. Higher loan amounts mean higher interest rates. Longer terms cost more. Think about the difference between a 30-year mortgage and a 15-year mortgage. Alternatively, a two-year car loan versus a seven-year car loan.
Your industry matters. Construction is perceived to be riskier than a dental practice. Restaurants are a bit dicey or riskier compared to an auto repair shop. The financing or insuring of a sports car like a Bugatti is more expensive than a Buick Regal. You get my point.