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Business loans can provide a vital source of funding, especially as there are many different types of financing to suit your specific requirements.
With any type of loan, it’s important to consider the cost of borrowing, including the interest rate (APR) and various fees. As some types of business finance are more expensive than others, you need to make sure you’re getting the right loan at the right price.
Here are the costs to consider before taking out a business loan, plus how to find the best deal for your business.
How much does a business loan cost?
The two main factors to consider when working out the cost of a business loan are:
- Interest rate: The interest rate you’ll be given is the biggest driver of cost for standard loans – it’s essentially what you pay to borrow money. The rate you get is influenced by factors including your credit profile, business finances and the type of loan you take out.
- Fees: Fees can add a meaningful cost to your loan. Lenders charge a range of different fees on loans from arrangement and set-up fees to charges for paying your loan late or early.
Aside from these, you’ll also need to consider:
- Loan amount and term: The amount you borrow and the term of your loan can affect the overall cost. Longer terms and higher amounts usually mean you’ll pay more interest overall before the loan is repaid.
- Associated costs: Some lenders may require you to pay broker fees and take out additional insurance, while legal and valuation fees are usually payable on secured assets.
What is APR?
When you take out a loan, you’ll usually be given an indication of the cost as an APR or Annual Percentage Rate. This is a truer representation of the overall cost of borrowing, as it factors in your interest rate as well as any fees and charges involved for a more complete picture.
The APR is most useful when you compare like-for-like loans over similar terms. However, it doesn’t include extra charges such as early or late payment fees, which may apply if you have trouble meeting your repayments or find yourself in a position to clear your debt early.
» COMPARE: Business loans
What are interest rates on business loans?
Interest rates on business loans vary widely between lenders and products. Lenders set interest rates based on the risk of the loan, which itself is shaped by your finances and credit profile, as well as the structure of the loan.
Fixed vs variable interest rates
Most lenders will offer both fixed and variable interest rates. A fixed interest rate will stay the same throughout the loan term, while variable rates can go up and down depending on other market factors, perhaps including the Bank of England base rate.
Fixed interest rates offer stability, so you’ll be able to predict your monthly repayments and be protected from any increases in interest rates. However, if interest rates drop, yours will stay the same and you won’t benefit.
It’s worth noting that some providers waive early repayment fees if you choose a variable interest rate, which means you can pay your loan off early without it costing extra.
Secured vs unsecured loans
You may have the option of choosing a secured or unsecured business loan.
Secured loans use one or more of your business assets as collateral. This means you offer an asset as security for the loan, giving the lender more confidence they can recoup the cost by taking the asset if the loan isn’t repaid.
The extra security might mean you can qualify for lower interest rates and potentially higher loan amounts – but your asset will be at risk if you default on the loan.
Unsecured loans aren’t tied to any assets as collateral. Instead, lenders use your credit and borrowing history to decide on your interest rate. Without security, you will need to have a good credit score to qualify for the best interest rates; with poor credit, your loan is likely to be more expensive.
» COMPARE: Low interest business loans
What fees are involved in business loans?
Aside from the interest you pay on the loan, you’ll also need to factor in certain fees you might face:
- Arrangement fees are charges for setting up the loans, sometimes also known as setup fees.
- You can expect to be charged late payment fees if you miss any repayments on your loan.
- Early repayment fees are often applied on fixed-rate loans rather than variable rate loans, and they can wipe out the benefit of paying your loan off early to avoid interest.
What are factor fees?
Factor fees are common with merchant cash advances. Instead of interest, you pay a fixed factor fee or funding fee.
What affects the overall cost of a business loan?
The overall cost of your business loan will be affected by the following factors:
- Loan amount: The more you borrow, the higher the cost is likely to be, as you will be charged interest as a percentage of the principal balance.
- Loan term: Borrowing for a longer term can reduce your monthly payments, but you’ll pay more in interest overall, making the loan more expensive.
- Secured or unsecured: Secured business loans tend to have lower rates than unsecured loans due to the security they require, but come with the risk that the asset could be lost.
- Fixed or variable: Fixed rates often start higher as you’re paying a premium for the certainty of knowing what your payments will be. Variable rates may start lower and offer the potential for payments to fall, but there’s also the risk they could rise.
- Loan type: Different types of business loans will have different costs, because of the various ways they’re set up, what they’re designed to do, and the risks they pose to lenders.
- Your business profile: Your business credit history, turnover and trading history are used to calculate the risk you present to the lender. The less risky you are to lend to, the better your chance of being offered the best rates.
» MORE: Business loan calculator
How to reduce the cost of a business loan
It’s worth considering the following tips to try and bring down the cost of your business loan:
- Improve your credit score: Borrowing responsibly, using a business credit card and repaying what you owe in full can boost your business credit score, helping you qualify for better rates.
- Organise your business finances: Having financial reports and forecasts for your business demonstrates good financial health and practice, which gives lenders more confidence in your ability to repay.
- Consider a secured loan: If your business has assets you can use as collateral for a loan, it can bring the overall cost down – but you do risk losing your assets if you default on repayments.
- Reduce your loan term: If you can afford to increase your monthly repayments, you could save money by choosing a short-term business loan, as you’ll pay less in interest overall.
- Repay early: Some lenders will let you repay your loan early without a fee, though this is usually only an option if you have a variable rate loan.
- Shop around: Comparing your options is the easiest way to find the best available loans for your business.
How to get a business loan through NerdWallet UK
In three short steps, we can help you find the best business loans – without affecting your credit score.
- Tell us about your business: share a few details so we understand your needs.
- See your matched lenders: view business loans from our panel of lenders that your company is most likely to qualify for.
- Compare and apply: choose a loan and apply directly with pre-filled details.
» COMPARE: Business loans
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