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There’s no shortage of financing options for small business owners. Some give you fast cash but come with daily repayment terms, others might take months or years to pay off. That’s not to mention all of the different loans out there for purchasing equipment, financing payroll, or turning outstanding invoices into cash. And that’s not even touching the loan application process, which is a whole different issue entirely.
If you feel like you’re up to your eyeballs in information, you’re not alone. The best place to begin is with the fundamental details behind how fixed rate business loans work, how you can get one, and what your lender will expect of you in terms of repayment.
Why are fixed rate business loans so important to understand? These business loans serve as a baseline upon which almost all small business loans are built. They allow borrowers to take out funds from a lender, and to repay the base loan amount—plus a steady (or fixed) interest rate—in daily, weekly, or monthly installments. Just about every kind of small business loan is a fixed rate loan. Since you’ll usually need to repay your loan shortly after obtaining it, it’s just not practical for lenders to offer loans with fluctuating, or variable, interest rates.
There’s a lot to learn about fixed rate business loans (and interest rates in general). Let’s get to it.
To understand how fixed rate business loans work, we first need to break down what interest rates are, and how they impact what borrowers pay their lenders.
In most cases, interest rates for business loans fluctuate with the general health of the economy. When the economy is thriving, interest rates tend to increase, since the value of money increases as well. On the flip side, when the economy is sluggish, interest rates often decrease. Affordable loans at low interest rates kickstart more lending activity, since they’re accessible for more businesses to secure.
So, how are interest rates determined? Essentially, that’s up to the government. The Federal Reserve sets prime interest rates—the baseline interest rate that lenders can offer borrowers. Then, lenders will add percentage points to this prime interest rate based on several factors. These factors can include (but are not limited to) the credit history of the company or individual applying for a loan, the industry the lender is in, the amount of money requested—basically, everything included on the borrower’s loan application.
Just about any loan you’d get for your business requires you to pay an interest rate. It serves as the lender’s incentive for letting you borrow money, as that extra cash ensures that the lender makes a profit off the loan deal. The fixed interest rate they offer you is the amount you pay on top of the portion of the loan you’re paying back to your lender.
Interest rates (literally) protect the lender’s interests. So, riskier borrowers—or, the businesses that are more likely to default on their loan payments—get stuck with higher interest rates, and the businesses with the strongest loan applications can often secure more affordable interest rates.
The primary reason that fixed rate business loans are the go-to form of lending available is the repayment terms that usually come with business loans. Most business loans require quick repayment—usually too fast for major interest rate hikes to go into effect during the course of the loan. That, and banks prefer to structure steady loan repayments with lenders and incorporate terms that dictate daily, weekly, or monthly payments depending on the kind of loan at play.
The short answer is, anything—within reason.
Fixed rate business loans are best thought of as a broad classification of lending products. There are a slew of loans available to small business owners, and most fall under the umbrella of a fixed rate business loan. Term loans, SBA loans, business lines of credit, and equipment financing—just to name a few—are all fixed rate business loans. (Just as a reminder, variable rate interest loans do exist, but they’re pretty rare.)
Although all of these loans come with fixed interest rates, their use cases differ. If you’re applying for a kind of Small Business Association (SBA) loan, for example, you can only use those funds as the SBA sees fit. For instance, 504/CDC loans only allow you to purchase equipment, machinery, or commercial real estate, while SBA 7(a) loans can be used for a wider range of purposes. The same goes for other use-specific loans, such as invoice financing or equipment loans.
When you’re shopping around for a business loan, you’ll need to know exactly what you intend to use your funds for, and choose the loan that aligns with your needs. That way, you’ll ensure that you’re not overpaying for money you’re not actually using.
As we mentioned above, fixed rate business loans are the standard with regard to financing options for entrepreneurs. Variable rate business loans do exist, but they’re not as common.
There are plenty of advantages to fixed rate business loans, chief among them being that you’ll receive a steady, predictable invoice from your lender when you need to repay.
Your interest rate won’t increase over time, and the amount you need to repay in each installment won’t rise, either. (The exception is if you’ve explicitly taken out a loan that requires higher payments toward the end of your term, such as a balloon loan.)
You can rest easy knowing that your obligations to your lender won’t fluctuate between payments. And if your business takes off, your payments will hurt a bit less as your liquidity increases.
For all of the perks of a fixed rate business loan, there are a few downsides as well. The biggest is the interest rate itself—unfortunately, there’s no such thing as a free loan. And if your lender deems your business “risky”—maybe your personal credit score is challenged, or your cash flow is stalled—then your interest rate may get pretty high.
And if you’re in the earliest stages of your business, you’ll likely pay a higher interest rate than you would if your company had a few years under its belt. Newer companies pose a bigger risk to lenders, since you have less of a track record of making money and paying off debts. So, most lenders will charge new businesses greater interest to recoup their expenses, in case you can’t make payments or your business goes under.
But if you’re stuck in a loan whose interest rates you can’t satisfy, you can consider refinancing your loans to take advantage of lower interest rates. You’ll have to make sure your personal credit is good (or has improved since you first took out the loan), that your company’s repayment history is strong, and that you can show an increase in revenue since you first borrowed money.
So, although you’re not able to lower your fixed rate business loan interest, you can find other ways of lowering your monthly payments.
Fixed rate business loans are the standard for most small business lending options, so you can expect a pretty standard fare on your business loan application.
Documents like your business tax returns, bank statements, profit & loss statement, and cash flow forecast (among others) help lenders determine your eligibility for the loan, and, if so, the interest rate they’ll attach to that loan.
Good personal credit, strong financials, a positive track record of your business’ profits and losses, and a demonstrated history of paying back loans on time all go a long way toward qualifying for a fixed rate business loan with good terms.
That said, the qualifications for fixed rate business loans vary depending on the kind you’re looking for. SBA loans are usually the best option for small business owners with great credit, since these loans carry the lowest interest rates on the market. Other borrowers might qualify for a bank loan without the guarantee of the SBA, which allows for a broader range of credit histories from their applicants.
Basically, your qualifications for fixed rate business loans will depend on what you’re applying for, so it’s important to know your financial history and loan purpose ahead of time.
Fixed rate business loans provide a great opportunity for entrepreneurs to finance the next big idea, or the exciting next step for their company. There are tons of options with regard to how much money you want to borrow, when you’re required to pay it back, and how much interest you can expect to pay.
But with any loan, you’ll need to know your company’s financial figures from top to bottom. Arming yourself with this information will help you pick the best fixed rate business loan for you.