Goulburn Post

6 factors influencing commercial loan interest rates

To be successful in securing a commercial loan at the best possible rate it's important to understand what influences those rates. Picture Shutterstock
To be successful in securing a commercial loan at the best possible rate it's important to understand what influences those rates. Picture Shutterstock

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When applying for commercial loan financing, one of the most important considerations is the interest rate you will pay. Interest rates on commercial loans can vary greatly depending on factors related to the borrower and the economic environment.

As a borrower, it is critical that you understand what determines the interest rate lenders will offer so you can improve your rate. This article explores six key factors that influence the interest rates lenders charge on commercial loans.

1 Credit Score

Your credit score is one of the top criteria lenders consider when deciding the interest rate to offer. A higher credit score indicates you're likely to repay debts-thus, pose less risk. Aim for a score above 720, which is generally considered excellent credit, to qualify for the lowest available rates.

There are specific actions you can take to boost your credit score over time, such as:

  • Always paying bills on time
  • Limiting new credit inquiries that trigger hard checks of your credit report
  • Keeping credit card balances low compared to their limits.

By consciously building your credit history, you can provide lenders assurance and improve the loan terms offered.

2 Downpayment Percentage

You should aim to make a downpayment of 20 per cent or more of the total commercial loan amount you request. A higher downpayment indicates you're financially committed to the project or business expansion the loan will fund.

Because a more substantial down payment lowers a lender's risk exposure, they have the confidence to offer you better interest rates and overall loan terms. Even an incremental increase in your down payment percentage from 15% to 20% can make a noticeable difference.

Stretch your available capital if needed to maximise your down payment. This investment upfront will pay dividends over the loan's duration through a meaningfully lower interest cost.

3 Loan Term

When negotiating the terms of your commercial loan financing, consider the duration or length of the loan term lenders propose. Opting for a shorter loan term often allows you to obtain a lower interest rate, all else being equal. This is because the lender's money is at risk for a shorter time frame before being repaid.

A shorter term also shows fiscal conservatism-that you do not plan to rely on debt financing longer than necessary. Ensure you can manage the higher monthly payments often associated with a shorter-term loan through realistic cash flow projections. The trade-off of higher regular payments for an overall lower interest cost may be worth it.

Still, be careful not to overextend yourself by agreeing to too short of a term that would risk default if business conditions changed. Find the right balance for your situation.

4 Purpose And Collateral

You can obtain more favourable interest rates by clearly communicating how you plan to use the commercial loan proceeds.

Capital expenditures, like investing in equipment, often qualify for lower rates because they may directly raise business revenues. Working capital loans that simply cover operating expenses are deemed riskier by lenders, leading them to charge higher interest rates.

You should also maximise your business assets and collateral to inform lenders you have something of value at stake. Leveraging tangible collateral like real estate, equipment, accounts receivable, or inventory helps reduce a lender's risk exposure in case of default.

The stronger the collateral, the more confidence lenders gain to offer you preferable loan terms and competitive interest rates.

5 Financial History

Companies with a track record of steady revenue growth and good cash flow are rewarded with better interest rates from lenders. Compile historical financial statements for the past 3-5 years showing stable or improving performance.

Quantify growth rates and profit margins, when possible, to showcase your financial fitness. Any clear upward trends will help justify your loan request and why lenders should have confidence in your business.

A compelling financial profile strengthens your leverage when negotiating for the most competitive rate on your commercial loan financing.

6 Industry Outlook

Your industry and its economic outlook influence the loan terms lenders will offer. Businesses in stable or growing industries like technology and essential consumer goods are considered lower risk and tend to receive preferable interest rates. Lenders view their revenues as more predictable, even in downturns.

Cyclical sectors like manufacturing and financial services, on the other hand, carry more risk of revenue declines in recessions, leading to higher rates. If your business is in an industry subject to volatility, you must thoroughly communicate the steps you take to mitigate risks and ensure stability, such as having a diverse customer base.

Final Thoughts

Interest rates have a major influence on the overall cost of commercial loan financing. By carefully evaluating and optimising the six factors discussed, you can reduce rates and maximise affordability. Find areas where you can reasonably improve to strengthen your negotiating position with lenders. With smart planning and preparation, securing favourable loan terms is an achievable goal.