A business loan is a credit granted by a financial institution (lender) to a business unit (borrower) intended only for business purposes, i.e., start-up or expansion of a venture.
This loan amount needs to be repaid in EMIs inclusive of the interest value.
This annual percentage rate (APR) is what a lender gains throughout the tenure of a loan cycle as its opportunity cost of lending. In other words, the rate of interest is the margin for the lender which they benefit by lending certain loan amount.
Thus the business loan interest rates play a significant role while seeking a loan.
RBI has instructed the financial sector on charging a minimum rate funding also called MCLR, i.e., the ‘marginal cost of fund based lending rate.’ The financial institutions refer to this rate as a benchmark and add their margin above it. The net figure is what they charge to the borrowers.
This rate of interest offered by the lending institution rests on specific underlying factors.
Determining factors of business loan interest rate
- CIBIL score:
Financial institutions like Bajaj Finserv check the CIBIL score first and ensures that the borrower had not defaulted in the past; thus minimizing the risk of future default payments by the borrower.
No lender would wish for a bad debt in their bookkeeping. As such, the higher the score better is the creditworthiness of the borrower. Lower risk of default accordingly leads to a lower rate of interest as well.
Business units which pledge certain assets for the loan can avail better deals regarding loan amount and rate of interest. Providing security means easily availing secured loans which work as a cushion to the lender, and they could offer loan amounts at lower rates. But business loans are unsecured by nature. Hence, unavailability of an asset as security leads the borrower to repay the loan at a higher rate of interest.
- Financial stability:
Good and regular cash flow means income exceeding payment, thereby increasing the profits for the borrower. This signifies a strong foothold on the finances and helps business units bag better rate of interest.
Revenues being relatively higher than payments cover up the EMI amount to be paid to the lender. Sustained revenues thus ascertain a lower rate of interest.
- Duration of the business:
The time spent in the industry helps the lender with better APR since longer the company has survived in the market, better will be the market reputation it possesses.
Disbursing loans to a new business unit involves specific risk for the lender which they cover by charging a higher rate of interest.
The above are the internal factors which a borrower can check upon for lower business loan interest rate. However, there are specific external factors which have no control over the borrower’s part. The list for these factors includes:
- Inflation rate: Direct relation with rate of interest.
- The monetary policy of RBI: Increase in liquidity implies a low rate of interest and vice versa.
- Supply and demand factor of loans: High demand and high rate of interest go hand in hand while the increase in the supply of funds leads to lower business loan rates of interest.
A lender charges different business loan interest rate from different business units on the same amount by evaluating their value and factors mentioned above. Thus one can increase the threshold of the loan amount by working on the above-discussed factors. It is the rate of interest that signifies how much a lender is comfortable in the deal.