Updated June 21, 2018.
There’s a metaphor so well-used that it’s almost a proverb, and it applies to this question.
Take a guy (presumably a guy you’re not very happy with). Take off his shoes. Stick one foot in a bucket full of ice water, and the other in a bucket full of boiling water. On average his feet are at a perfectly comfortable temperature.
Asking what the average interest rate is for small business loans is similar to the problem for that guy’s feet. There are different kinds of product, different kinds of business and different kinds of risk. Each of these factors demands a different rate of interest, and they combine to modify those rates in ways that make a categorical “average” as misleading as a lie.
Here’s your guide to small business loan interest rates and what you might expect yours to look like. It begins with the following questions:
What kind of small business loan?
Small business loans typically break down into two types: installment loans and lines of credit.
- An installment loan works like your car loan. You borrow a set amount of money. You make monthly payments on the loan until you’ve paid back the interest, plus the fees, plus the amount you borrowed. When the balance reaches zero, the loan is paid in full and your relationship with the lender is over.
- A line of credit works like your credit card. Your lender sets a maximum amount of money you can borrow at any one time. As you need it, you borrow against that credit limit to provide your business with working capital. Each month, you pay back what you can (usually with a set minimum). Funds may or may not replenish depending on the type of line of credit.
These are two very different kinds of financial relationships. In general, an installment loan cost less to maintain and is a more secure investment for the lender (because it provides reliable monthly income, and because they are statistically more likely to be paid back in full). This means lenders can offer installment loans at a lower rate of interest than a line of credit.
Comparing an installment loan’s interest rate to a line of credit’s interest rate doesn’t give an accurate assessment of the better loan. The line of credit offers convenience and flexibility not present in an installment loan, but those features do cost a bit more because of the cost and risk they carry with them.
Where is the hidden interest?
Not all costs of a loan are found in the APR listing. Take for example two one-year installment loans for $5,000, both of which charge 5 percent APR. With a little fudging of how interest works to keep this example simple, both loans will cost $250 in interest by the time they’re paid off. However, one loan charges a $100 setup fee and a $10 per month processing fee. That’s an additional $220 per month, bringing the cost of that loan to the equivalent of 9 percent APR – nearly twice the cost of the other loan.
When comparing only the interest rates of two competing loans, you aren’t getting a complete picture of the cost of the loan. You must include the cost of any fees and charges if you want to make the most informed decision possible.
What’s the bottom line?
You clicked on this article to learn the average interest rates of small business loans, presumably because that information will help you make a decision. With the information above in mind, here is the most complete information we could find:
With (sometimes significant) variations according to region, industry and credit rating, the average annual interest rates on small business loans are:
- For Business Installment Loans, the average APR can range anywhere from 2.5 percent to 71 percent. However, these typically skew toward the lower end of the spectrum the higher the amount of the loan.
- For Business Lines of Credit, the average APR can range anywhere from 8 percent to 80 percent.
The advantages of a line of credit may outweigh the costs, however. For example, with a line of credit, once you’re approved, you can borrow funds whenever you want. You don’t have to take the money and begin payments immediately (like with your standard business loan). You also only pay back what you borrow. Let’s say you’re approved for a line of credit of up to $250,000, and you only borrow $50,000. You only make payments on that $50,000 (not the total line).
In both cases, these numbers don’t include the fees we warned you about earlier. Fees range wildly for both kinds of loans and are a common trick used by predatory lenders to make their loans nearly impossible to pay off. Make sure you read the terms of any funding you borrow to ensure there are no hidden fees you’ll be hit with.
Asking this question shows you already know one of the most important aspects of shopping for small business credit: How much is this going to cost and is it a fair amount? All smart business owners should ask this question about any kind of loan, advance or line of credit.
All written content contained on this page is for informational purposes only. The material presented is believed to be from reliable sources; however we make no representations as to its accuracy or completeness. Please consider and discuss all facets of your business and financial needs in consultation with a professional prior to implementation.