If you are a business owner searching for the most suitable business loan in India, it is crucial to understand the interest rate associated with it. An interest rate is the cost of borrowing money, expressed as a percentage of the loan amount. It represents the amount you need to pay in addition to the principal loan amount.
How do lenders decide your business loan interest rate? In this blog, you’ll understand what affects your interest rate and how to increase your chances of securing a lower rate.
Your business’s credit score is the primary factor that financial institutions consider. It is a numerical representation of your creditworthiness based on your past and current financial history. An ideal credit score is 750 or more.
A high credit score indicates that you are a responsible borrower, and lenders are more likely to offer a lower interest rate. At the same time, a lower credit score may lead to a higher interest rate or a loan denial.
Your business’s financial health also determines the interest rate on a business loan, as financial institutions carefully assess financial statements such as the balance sheet, profit and loss statement, and cash flow statement.
For instance, loan issuers consider a business with stable profits and cash flow as a less risky borrower, potentially securing favourable loan terms like lower interest rates. Conversely, if a business faces financial challenges or irregular cash flow, lenders may charge higher interest rates to offset the potential for default.
Loan providers assess the risk associated with lending to various types of businesses, which impacts the interest rates they offer. For example, businesses with substantial tangible assets, such as manufacturing firms with machinery and inventory, generally have lower risk. Using these assets as collateral can also lower business loan interest rates.
On the other hand, service-based businesses, such as consulting firms or marketing agencies, may lack significant tangible assets to offer as collateral. This lack of physical security increases the perceived risk for loan issuers, leading to higher interest rates.
Simply put, industries with persistent growth and stability attract lower business interest rates, whereas industries facing economic challenges such as declining demand or regulatory issues may face higher rates.
For example, consider the technology sector, which has been experiencing rapid growth and innovation in India. A tech startup seeking a business loan may benefit from the lower business interest rate owing to the sector’s strong performance and positive outlook.
Similarly, a business in the coal mining sector facing regulatory constraints could attract higher business loan rates. Thus, the higher risk associated with the industry’s challenges prompts loan providers to charge more to mitigate potential losses.
When the RBI raises the benchmark interest rate, businesses' borrowing costs typically increase, whereas a lower rate can lead to more affordable business loans in India. In times of high inflation, loan providers increase interest rates to safeguard their returns.
Additionally, global economic factors, such as changes in the international interest rate or geopolitical instability, can cause Indian lenders to adjust their rates proportionally. One thing to note is that government policies favouring loan issuers, including tax and regulatory changes, can lower the interest rates on business loans.
When you pledge collateral (asset or property) against a loan, there are two outcomes: a higher or lower interest rate. Often, providing valuable collateral qualifies for a lower interest rate as it acts as a security for loan providers in case of default.
The type and liquidity of your collateral also play a role. Liquid assets like cash lead to a lower interest rate, while non-liquid assets like real estate result in a higher rate because they don’t convert quickly into cash.
When you apply for a business loan , the interest rate tends to vary inversely with the loan amount. A larger loan amount attracts a lower interest rate because of economies of scale and the greater potential for lenders to earn more interest over the loan term.
However, you might face a higher interest rate if you seek a smaller loan. Many financial institutions consider smaller loans riskier because they bring in less revenue and are more likely to default.
Loan tenure is the period for which the loan is taken, and it could significantly impact your business loan interest rate. Generally, a long-term loan has a higher interest rate as it poses a greater risk from potential economic changes affecting your repayment ability.
On the other hand, a short-term loan, seen as less risky, usually comes with a lower interest rate. Therefore, you must carefully consider the repayment tenure when seeking a loan, as it directly influences the overall cost of borrowing.
In India, the types of business loans you choose can significantly influence the interest rates offered to you. Different loan types—term loans, working capital loans, cash credit, and more—come with varying interest rate structures.
For instance, a secured business loan, which requires collateral, generally has a lower interest rate than an unsecured loan, which carries a higher rate because of the increased risk for the financial institution.
Each lender operates with its guidelines for determining your business loan interest rate. Some lenders offer lower rates for particular industries or loan types that align with their distinct requirements. However, there can be cases where these loan issuers are willing to work with businesses with poor credit histories or limited financial resources. Still, the interest charged to them is higher to offset the high risk.
Also, if you have a strong relationship with the lender, such as a history of on-time payments or a long-term business account, you may receive more favourable loan terms and interest rates.
To get the best business loan interest rate, consider these 10 factors and make sure you're making the right decision for your company's financial future. On Quid, you can compare various lenders and interest rates, ensuring you make the most advantageous choice for your business.
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