How Are Business Loan Rates Determined?

Business loan rates generally rely on the credit worthiness of the borrower. It is true that a business plan and revenue can significantly impact the size of a business loan. When it comes to rate, however, lenders are most concerned with how responsible the borrower has been with debt in the past. A credit score is the truest sign of responsible borrowing. Both the business's credit and the business owner's credit may be considered.

New Businesses Use Personal Credit

When an entrepreneur is first starting a business, the business itself will not have an independent record of debt and repayment. As such, it will be necessary for lenders to consider the business owner's credit score when sourcing the loan. The business owner will have to place his or her name on the contract. If two people are going into business together, they will likely share the burden of the debt. In this case, both of their credit scores would be used to determine an appropriate loan rate. A history of repaying installment debt will help reduce loan rates. Any late payments or defaults can be red flags for lenders. Repaying revolving debt, like credit cards, is not as important. However, borrowers should show they maintain low balances on credit lines and always meet monthly payments.

Established Businesses Use Business Credit

Once a business has been operating for some time, there will be a record of how well the business has managed its debts. The business will have a complete financial report, including assets, revenues and expenditures, that can be used to evaluate how solid the company is financially. In this case, the business itself can apply for new loans. As soon as it is possible for a business owner to remove his or her name from loan applications, the step should be taken. This protects the business owner personally if the company should fail in the future. It typically takes years for a business to get to that point. The loan rates the business can achieve in the future will be solely based on how well the company is performing, including repaying debts and generating new revenue. Successful companies that exceed financial projections and repay debts quickly will receive the best loan rates. 

Assets Placed as Collateral

Placing assets as collateral can significantly reduce the rates quoted on a loan. At first, a business will not have its own assets to use as collateral. Personal assets of the business owner may be used. However, in the case of a bankruptcy or default, the business owner could face aggregated risk by having personal assets on the line. As soon as a business is profitable enough to build an asset base, those business assets should be used to replace personal assets used on secured loans. Even when a business succeeds for many years, a sudden change can have very disastrous circumstances. Many business owners make the mistake of allowing their personal finances to be compromised when this occurs. Using only business assets as collateral will protect a business owner down the line.