A line of credit allows you to access funds as needed up to a predetermined limit, making it an attractive option for unexpected expenses or cash flow management.
However, the interest rates associated with these lines of credit can vary significantly based on factors such as creditworthiness, lender policies, and market conditions.
So, what aspects and factors should you pay attention to? How to calculate interest rates?
Answers to all these questions and more lie in our blog. Read on to find all you need to know about the average line of credit for a small business.
Let’s dive in!
What Is an Interest Rate?
The interest rate is the portion of the main loan amount lenders require you to pay for borrowing money.
It is usually an annual percentage rate (APR), which indicates the overall yearly expense of taking out the loan, covering any related fees or extra costs.
If this concept is new to you, don’t worry. We’ll talk more about APR in the lines that follow.
4 Most Common Types of Interest Rates
1. Annual Percentage Rate (APR)
The most common interest rate type is APR, which usually ranges from 8% to 60% or higher.
Speaking of lines of credit, average rates for new business lines of credit in early 2024 were between 7.58% and 9.35%.
The specific rate offered depends on your credit profile, with better rates available if you have good to excellent credit.
However, some lenders don’t rely on the APR system but use different methods instead.
2. Weekly or Monthly Fees
Some lenders charge fees based on the amount borrowed, calculated weekly or monthly, rather than using a traditional APR structure.
For example, a lender might charge 2% monthly on the outstanding balance.
While this might seem lower than an APR of 15%, the total cost can accumulate quickly if you don’t repay the borrowed amount promptly.
Thus, if you borrow $10,000 and incur a 2% monthly fee, you would pay $200 each month, totaling $2,400 over a year, which translates to an effective APR of 24%.
Conversely, an APR of 15% on the same amount would result in approximately $1,500 in interest over a year, making it more favorable in this scenario.
However, comparing these 2 structures can be tricky and complex since not all lenders disclose their fees in a way that allows for easy comparison with APRs.
Some may present simple interest rates that exclude fees from their calculations. Thus, it is essential to read the fine print to understand the total cost of borrowing.
3. Factor Rates
Short-term lenders and merchant cash advance providers may charge a factor rate. When a lender charges a factor rate, they apply a multiplier to the principal amount of funding you receive.
This multiplier, known as the factor rate, plays a critical role in determining the total cost of the financing.
Factor rates typically range from 1.1 to 1.5, meaning that if you borrow a certain amount, the final repayment amount will be that initial sum multiplied by the factor rate. For instance, if you receive a loan of $10,000 and the agreed-upon factor rate is 1.3, the total repayment amount would be $13,000.
These financing options often appeal to businesses that require quick access to capital but may not qualify for traditional loans.
📢 Good to Know: Factor Rates Challenges
However, bear in mind that while providing immediate access to much-needed funds, factor rates can translate into exceptionally high APRs.
The reason for this is that you often repay short-term loans over a relatively brief period — Sometimes as quickly as a few months.
Moreover, factor rates don’t include additional fees such as processing fees, late payment fees, or other administrative costs.
These extra expenditures can further increase the overall cost of the financing. Therefore, it’s crucial to evaluate the comprehensive cost of borrowing, including all potential fees and the total amount you’ll ultimately repay.
4. Fixed Interest Rates
A fixed interest rate remains constant throughout the loan or line of credit. This means that your monthly payments will not change, providing predictability in budgeting.
You are shielded from these increases if market interest rates rise since your repayments remain stable.
On the other hand, if market rates decrease after securing a fixed rate, you miss out on potential savings unless you refinance.
5. Variable Interest Rates
Variable interest rates fluctuate over time based on changes in market conditions or benchmark rates, such as the prime rate.
Consequently, monthly payments can increase or decrease during the life of the loan.
Variable-rate lines of credit often start with lower interest rates than fixed-rate options, making them attractive for short-term borrowing or if rates are expected to remain stable or decline.
Nonetheless, the primary drawback is the unpredictability of payments due to potential fluctuations in interest payments.
In addition, the longer the term of a loan with a variable rate, the greater the risk that rates will increase significantly over time, potentially leading to higher overall costs.
How to Calculate Interest Rates?
The average daily balance method and simple interest rate are interconnected concepts to calculate interest on loans, particularly lines of credit.
Both methods aim to calculate how much interest you owe based on the amount borrowed.
However, the average daily balance method provides a more nuanced approach by considering fluctuations in balance over time.
On the other hand, simple interest applies only to the principal.
1. Simple Interest Rate
This straightforward method of calculating interest is based solely on the principal amount borrowed.
Therefore, it doesn’t consider any compounding effects or changes in balance over time.
For instance, if you borrow $10,000 at a simple interest rate of 5% for 1 year, the total repayment would be $10,500.
2. The Average Daily Balance Method
The average daily balance method calculates interest charges based on the outstanding balance of an account over a specific billing period.
You need to calculate a few factors:
- The sum of Daily Balances — Add up all the daily balances for each day in the billing cycle.
- Average Daily Balance — Divide the total daily balances by the number of days in the billing cycle.
Thus, calculating interest involves summing the daily balances throughout the billing cycle and dividing the figure by the number of days in that cycle to determine an average.
Let’s say your APR is 20 %, and your daily balances are as follows:
- Days 1-10: $1,000
- Days 11-20: $1,200
- Days 21-30: $1,500.
🔢 First, you’d calculate total daily balances: (1,000x10)+(1,200x10)+(1,500x10)=10,000+12,000+15,000=37,000.
🔢 Then, you’d calculate the average daily balance:
37,00030=1,233.33, and daily periodic rate: 20% / 365=0.0548%
🔢 Finally, you’ll be able to see your interest charges: 1,233.33x0.000548x30=20.25
Thus, you would owe approximately $20.25 in interest for that billing cycle.
How do You Calculate The Total Cost of a Business Line of Credit With Fees?
As we’ve already mentioned, interest rates depend on multiple factors.
Still, there are a few steps you can follow to calculate the total cost of a business line of credit, including any applicable fees.
Step 1 — Identify the Withdrawal Amount
Determine how much you plan to draw from your line of credit. This is the principal amount on which your lender will calculate interest.
Step 2 — Determine the Annual Percentage Rate (APR)
Check the interest rate associated with your line of credit with your lender, including any fees incorporated into the APR.
It will depend on various factors, such as creditworthiness and lender policies.
Step 3 — Calculate Interest Costs
Use the formula mentioned in the previous paragraph to calculate a simple interest rate.
Step 4 — Add Fees
Identify and sum any additional fees associated with the line of credit, such as:
- Processing Fee: A fee for opening a business line of credit, which covers administrative costs related to underwriting and approving your application
- Origination Fee: A one-time fee for processing the line of credit.
- Annual Fee: A yearly charge for maintaining the line.
- Draw Fees: Fees charged each time you withdraw funds.
- Maintenance Fees: Monthly or annual fees for keeping the account open.
- Late Payment Fee: Fees you pay if you miss a payment or fail to make timely payments.
Step 5 — Calculate Total Cost
Combine the total interest and fees to get the overall cost of using the line of credit.
What Factors Influence The Business Lines of Credit Interest Rate?
Different lenders offer varying interest rates based on their lending criteria and risk assessments.
Traditional banks may provide lower rates but have stricter requirements, while online lenders may charge higher rates due to more lenient approval processes.
Several factors influence the business lines of credit interest rate:
1. Creditworthiness
The credit score of your business and your personal credit score is one of the most significant determinants.
A higher credit score indicates lower risk for lenders, often resulting in lower interest rates. Conversely, a lower credit score may lead to higher rates due to the potential risk of default.
💡 ProTip:
Did you know that Puls Project doesn’t run any credit checks but focuses on your cash flow management instead?
We only require the loan agreement and personal identification of beneficial owners and directors as per GwG.
2. Economic Conditions
Broader economic factors, such as inflation and overall economic stability, play a crucial role. During periods of economic growth, interest rates tend to be lower as lenders are more willing to take risks.
In contrast, rates may increase during economic downturns or periods of high inflation to compensate for higher risk.
3. Industry Risk
Different industries carry varying levels of risk.
For example, businesses in volatile sectors, such as energy, agriculture, etc., may face higher interest rates due to the increased likelihood of financial instability.
Lenders assess industry-specific risks when determining rates.
4. Loan Amount and Term
The size of the line of credit and its repayment term can also affect interest rates.
Generally, larger loans or longer terms may come with higher rates due to increased exposure for lenders.
Conversely, smaller amounts or shorter terms might attract lower rates as they are seen as less risky.
5. Type of Business
We’ve already mentioned that the volatile sector may face higher rates.
Service-based businesses that lack physical collateral may also experience higher rates than businesses with substantial tangible assets like manufacturing.
6. Collateral
Secured lines of credit requiring collateral like inventory or equipment usually have lower interest rates than unsecured lines, as collateral reduces the lender's risk.
For example, suppose you take out a secured line of credit against your inventory.
In that case, the lender is more likely to extend credit at a lower interest rate because they know they can recover their investment by selling the inventory in the event of default.
On the other hand, unsecured lines of credit don’t have this safety net, which means that lenders face a higher level of risk.
As a result, to compensate for this potential risk, lenders typically impose higher interest rates on unsecured loans.
7. Time in Business
Established businesses typically receive better rates than startups because they have a proven track record and financial stability, reducing potential risk for lenders.
Lenders are generally more inclined to extend favorable rates to established businesses because their historical financial data provides a clearer picture of:
- Their earnings,
- Profit margins, and
- Cash flow stability, significantly reducing the perceived lending risk.
On the other hand, startups must work harder to build credibility and financial history to overcome the challenges they face in securing funding.
💡 ProTip:
Although most lenders ask for a minimum of 1 year of business running, here at Puls Project, we grant loans to businesses running for at least 6 months.
Additionally, we provide cash flow management tools to help you improve credit limits through consistent and real-data-based financial planning.
Thus, you can:
🔥 Track balances and spending across different accounts and companies in a single view.
🔥 Increase your credit limit based on regular income and expense planning by relying on the real-time transaction data that we sync multiple times daily.
🔥 Schedule draft payments to immediately see their impact on your balances so you can make more informed decisions.
🔥 Instantly detect any cash gaps and potential risks, enabling you to be proactive and eliminate them.
🔥 Group and label your transactions and activities for a more organized and comprehensive view that lenders will look favorably on.
8. Annual Revenue
Higher annual revenues demonstrate your business's ability to repay loans, which can lead to more favorable interest rates.
Lenders are more inclined to offer lower rates if you show strong financial performance.
Knowing which factors to focus on can help you identify and improve your weak spot and potentially secure better financing terms.
🎁 Bonus: 3 Tips to Negotiate a Lower Interest Rate on Your Line of Credit
Negotiating a lower interest rate on your line of credit can lead to significant savings. Thus, we provide a list of hot tips to help you achieve a better rate.
1. Research Competing Lenders and Offers
Compare and contrast lenders you are interested in and gather all the information that can come in handy when you start negotiating.
Do they have better terms, lower interest fees, etc.?
2. Check Your Credit Score
A higher credit score can strengthen your negotiating position.
According to the Experian scoring system, a “good’ score” should be between 881 and 960, while “fair” should be between 721 and 880.
However, it is important to remember that each lender may have different views on what they consider ideal.
In addition, depending on the loan type, some lenders only do a soft credit check which doesn’t affect your credit score or report.
3. Review Your Payment History
Gather evidence of your responsible payment behavior, such as on-time payments and a low debt-to-income ratio, since it demonstrates your reliability as a borrower.
💡 With Puls Project, you can view balances of all accounts in one glance, manage invoice payments efficiently, and maintain a clear history of payments.
Another vital aspect to remember is that if your lender agrees to a new rate, ensure you receive written confirmation to avoid any misunderstandings later.
❓ But what if your request for a lower rate is denied nonetheless?
The good news is that there are a few alternative benefits that can reduce your overall borrowing costs.
Wrapping It Up
While lines of credit can offer flexibility and immediate access to funds, it’s essential to consider the associated costs, such as fees and repayment terms, which can significantly impact your overall financial obligations.
Always remember to shop around for the best rates and terms that align with your business needs.
Puls Project can be a great assistant in not only providing you with favorable loaning terms but also offering tools to enhance cash flow management, an inevitable factor in any loan screening process.
How Can You Amp Up Your Financial Management with Puls Project?
Puls Project is a robust FinTech solution that caters to SMEs and provides tools to:
- Access necessary funding.
- Centralize all companies and accounts in a single platform, and
- Improve cash flow management to increase credit limits and streamline financial operations.
With Puls, you can:
🔥 Easily apply for a loan without credit checks or collateral.
🔥 Get up to €100,000 for a 12-month period.
🔥 Achieve the highest possible credit limit by linking all bank accounts from your companies.
With a clearer understanding of your financial position and how you manage your cash flow, we can increase your borrowing cap.
🔥 Tailor the loan to your needs and calculate the total cost, total, and monthly interest rate with our Loan Calculator.
🔥 Link any bank account from over 4,000 banks to simplify cash flow management by adding your planned financial transactions in every connected bank account on a single platform.
🔥 Create payment orders based on your planned transactions.
🔥 Get real-time insights into spending patterns and cash flow, making it easier to know if you have enough money.
🔥 We’ll monitor your cash flow actively and inform you immediately in case of a potential cash gap, so you can win time to adapt either by:
- Reducing costs
- Moving the planned payments
- Getting financing from your regular source or soliciting a loan from us.
And so much more.
Ready to dive into Puls Project?
Sign up for Puls Project today and combine excellent loaning possibilities with efficient cash flow management.
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