Why Small Business Loan Interest Rates Are So High

Why is the Interest Rate on Small Business Loan Rates So High?

There is an old adage in banking called the three C’s of banking. Character, Capital, & Capacity.

What is the Character of the business asking for the loan? Is the business established? What industry is the business in?

What Capital does the business have? Does the business have sale-able assets like real estate to secure the loan with? Does the business have receivables?

Does the business have Capacity to repay the loan?  Is the business profitable? What interest rate can the business afford?

Small businesses do not have many options when it comes to getting a loan from a bank.Small Business Interest Rates Federal Reserve

Banks want to see a business has been profitable for the past two years. Banks want to know that their loan is secure and will be repaid. Banks are risk averse, meaning they only lend on a sure thing. For example, banks look for scenarios like this: A borrower asks for $100K to buy a building that is on sale for $200K. The building is rented out at a rate of $20K a year to a national corporation for the next 15 years, and the borrower is putting $100K. Banks love deals like this. They usually charge a low interest rate of prime plus 2%.

For Small Business Owners, this does not work.

Small business owners are usually in this situation:

The small business has the opportunity to start selling to a new, yet very large customer. The new customer is so large and they say, we will pay you after 90 days. The new customer is going to start buying $50K a month of good and services. This small business owner is use to $20K a month in sales. Where is the business owner going to find 3 months worth of cash to pay suppliers while waiting for the new customer to pay.

What this small business owner need to do is look for a company that specializes in financing receivables, also know as factoring. The interest rate for receivable financing can be as low as 8% to as high as 30%. These interest rates can be monthly or annual.

Many lenders will loan to small businesses, but these are not your large banks like Wells Fargo and Bank of America. Small business owners need to look for lenders who have experience lending in their specific industry. Industry associations are sometimes helpful, and franchisors sometimes have a preferred lender in place for their franchisees.