How to Calculate the Interest Rate on a Business Loan

Jul 04, 2022 | BLOG

Are you planning to apply for a business loan? Before you do, there are a few things you must consider first. On top of the list is the business loan interest rate. You need to take interest rates into account because they will determine the total amount of money you will owe and eventually have to pay. Knowing how to calculate the interest rate on a loan is helpful for business owners. But you need to understand what drives your rates up or down, so you can come up with ways to lower your interest and, consequently, the total cost of your business loan.

What is an Interest Rate?

Before we get to the nitty-gritty, let’s begin by defining the subject at hand. What is interest rate exactly? Essentially, interest rates let lenders earn from the loans they issue to worthy applicants. A payment agreement that stretches over a specified period will entail the borrower paying a portion of the principal amount owed and a portion of the interest rate every month. The loan agreement ends once both the principal amount and its corresponding interest rate have been paid. Paying for interest means you’re paying more than the amount you borrowed. As such, you want your interest rate to be as low as possible to minimize your overall expenses.

How to Calculate Interest Rate on a Loan

Think of interest rates as the cost of borrowing money. They come in two main categories: fixed and floating. The former stays constant throughout the loan term, whereas the latter fluctuates relative to a reference rate. Meanwhile, in terms of calculation, there are two more types, namely simple and compound. Simple interest calculation follows this formula:
Principal x interest rate x loan term
To illustrate, let’s say that you borrowed 10,000 that has to be paid in 2 years. The agreed interest rate is 3%. Therefore:
Simple interest: ₱10,000 x 3% x 2 = ₱600
This means you’ll be paying ₱600 on top of the ₱10,000 you borrowed. Your goal is to pay the combined portions of the principal loan and interest rate every month on time and in full. Otherwise, you might be charged a late payment fee, or your outstanding balance would gain interest. If the latter happens, you would have to contend with ballooning compound interest, which is basically interest on interest.

What Factors Affect Interest Rate?

The loan provider decides the interest rate they’ll offer to you, but they look into several factors, such as the following.

1. Market and inflation

Socio-political and economic factors affect people’s capacity to pay loans. That’s why loan providers factor these when determining interest rates. For instance, expect higher interest rates if there’s political unrest in your area of business or when the market you want to cater to is experiencing a downturn. For these reasons, timing is key. If possible, wait for these factors to stabilize before applying for a business loan.

2. Business history

It’s easier for existing brands to apply for a business loan, such as those looking to expand or branch out, because they already have a history of successful operations or fully repaid loans. Of course, first-time entrepreneurs can also apply for a business loan. However, they might need a foolproof business plan to convince loan providers of their merit. The business plan should prove that there’s a robust market for the business.

3. Company financials

Established businesses will have to show loan providers some documents that prove their financial sustainability. These may include asset and liability ledgers and tax returns. Meanwhile, lenders look at personal credit rating and history in the case of newbie entrepreneurs. If you fall into the latter category, improving your personal credit rating is in your best interest before applying for a business loan. One way to do so is by paying your credit card bills on time.

4. Collateral

Do you have valuable assets for collateral? If so, chances are you’ll receive a better loan interest offer. Assets like real estate, cars, and even artwork assure loan providers that there’s a way for them to recoup what you owe by way of collateral seizure in case you fail to pay up.

5. Loan product

You can either apply for a short- or long-term business loan. The longer the payment duration, the higher the interest rate. That’s because there’s a bigger risk that the loan may not be repaid. The business might go bankrupt even before the loan has matured. A shorter loan term would mean chipping off more on the principal loan amount every month, with a corresponding small interest rate. Make sure to choose a loan program that suits your priorities and financial capacity.

Apply for a Business Loan Today

Applying for a business loan requires careful planning, research, and consideration. Do not sign above the dotted line without comparing loan agreements from different providers. This way, you can ensure the best possible loan terms. If you’re a small business in need of a financial push, check out JK Capital’s business loans. Our loans have minimum requirements and provide fast approval, so you can jumpstart your business ASAP. Contact us today to secure business funding in 7 days or less.