This article is for small business owners who are interested in learning more about bank loans. We scoured the web and spoke with banks and small business finance experts to find the typical requirements and interest rates for a non-SBA bank loan. After reading, you’ll know whether or not you’re likely to qualify for a bank loan and roughly what interest rate you can expect to pay.
Small Business Bank Loan Rates
We found that interest rates for small business loans from banks generally range between 6 and 13 percent, depending on the size of the loan and the risk factor of your business.
|Profitable Yrs in business
|Personal Credit Score
|Size of Loan
|more than 3 years
|800 to 850
|More than $350,000
|2 to 3 years
|700 to 800
|$100,000 to $350,000
|660 to 700
What Determines Interest Rates?
No matter the size of your business, there’s always interest rates on loans. This is so the bank earns a profit and cover their overhead. The absolute lowest interest rate a bank will charge is called the prime rate. It’s only given to clients with the lowest chance of default, which is typically large corporations. The prime rate usually fluctuates with the ebb and flow of the economy, but since 2009 it has rested at 3.25%.
Small businesses inevitably have a higher risk profile than large corporations, so they almost always have to pay higher interest rates. This is because the bank has to account for the chance you’ll default on your loan. If 1 in 100 small business loans default, then they have to regain that loss by charging higher interest rates.
To determine the risk factor of your business, banks undergo the process of underwriting: a deep analysis of your business’s finances (as well as your personal finances), to determine how likely you are to repay the loan. Doing so, the bank will decide whether or not to approve your loan and, if approved, how much interest they should charge.
These 5 factors pull the biggest weight in underwriting:
- Capacity. Your current ability to pay your business expenses based on your revenue and the likeliness you can continue paying them with additional loan fees. Lenders also consider the length of time you’ve been in business and for how long you’ve been earning a profit.
- Credit History. What is your personal credit score and (if applicable) the credit score of your business.
- The size of the loan. Smaller loans typically come with higher interest rates. This is because banks do not earn as much profit from small loans as they do from large loans.
- Collateral. Small business loans typically require a personal guarantee, so if the business goes under you and your co-owners are responsible to pay back the loan. If you have a lot of personal assets, like a home or vehicle or investments, you can usually put these up as collateral and secure a lower interest rate.
- Conditions. Banks make a profit by lending money at a higher rate than they borrow it. If capital is tough to come by, then interest rates are going to be high. Likewise, if there’s a lot of competition for loans in your area, or if an event like a natural disaster causes more businesses to seek capital, then interest rates may also increase. Despite the recent economic downturn, however, rates have been at a historic low since 2009.
#1. Capacity: An In-Depth Look
If there’s one thing banks look at, it’s going to be capacity: your ability to repay loans based on the revenue and expenses of your business. If it’s not likely you can handle the additional loan payments on top of your other expenses, then you aren’t likely to be approved.
It’s also important to show that your business will keep its profits up for the duration of the loan. This can usually be done by looking at the history of your business. How long have you been a profitable business?
I had a conversation with Tim McCausland, who represents Orange County Trust, a community bank in New York. McCausland explained that they generally like to see 3 years of profitable history in a small business client. Larger banks can be a little more lenient, but tend to require at least 2 years of profitable history. In general, the longer you’ve been in business, the less risk you hold as a client. Thus you can expect to see lower interest rates on a bank loan.
#2. Credit History
Banks will look at your personal credit score as well as the credit score of your business. This further shows your capacity to repay the loan as well as a tidbit on your character: How much do you prioritize repaying debts? You could earn a lot of revenue, but still be late on payments. This will come up as a red flag to banks.
Anyone with a personal credit score below 660 is typically not considered for a bank loan. Individuals in the 700 – 800 range fare a little better. Those with a score of 800 or higher have the best chance of approval and will see the lowest interest rates.
Business credit scores are measured a few different ways so there’s no single standard. For PAYDEX, a credit score of 80 will put you in a good position. For Experian, however, 70 is considered a good score.
#3. The Size Of The Loan
To explain why the size of the loan matters, you first need to know a little about how the process works. In most banks (especially smaller and mid-size banks) underwriting is tackled by hand. Bank employees personally review your loan request, determine your capacity, credit score, collateral, etc. It takes roughly the same amount of time and effort whether the loan is for $1,000,000 or $10,000. As you’d expect, banks prefer larger loans and will charge higher interest rates for small loans to recoup the cost of time.
Because of this, McCausland explained, most banks won’t consider loans to new clients below $100,000. For returning clients, however, the process is easier and there is less risk, so they can consider smaller loans.
There is an exception for larger banks that automate the underwriting process. Because it doesn’t take as much time or manpower to review an application, these banks can sometimes consider smaller loans.
Small businesses are not always successful and many go under within the first few years. To protect themselves in the event of a default, banks usually require small business owners to sign a personal guarantee. This means you’re personally responsible if your business can’t repay the loan and if you don’t have the cash, the bank can go after your assets.
You might also be required or given the option to put up personal property as collateral, such as your home or car. Banks will usually accept assets at around 75 percent of their appraised value. So if your home is worth $400,000 it can be used to cover $300,000 in debts. You can typically use collateral to secure a lower interest rate, but it ultimately depends on the policy of the bank.
#5. Other Factors
Personal character can play a major role, especially at smaller community banks. Are you well known in the community and do you have a good, reliable reputation? After capacity, the character can be the next biggest factor in a community bank’s decision whether or not to approve the loan and set interest rates, according to McCausland. For larger banks, especially those who automate part of the underwriting process, character won’t play as large of a role.
Another factor that all banks consider is how much you have personally invested in your business. If a lot of your own cash is riding on your success, the bank will take notice favorably. On the other hand, if you don’t have much personally invested, the bank might see this as a sign that you don’t have faith in your business.
In summary, here’s what we found to be the minimum requirements for a small business bank loan if you’re a first time customer:
- 2 years of profitable history
- A personal credit score above 660
- Loan of at least $100,000
- Personal guarantee on loan with collateral