Business Loan

Top reasons why you should know about business loan interest rate in 2022


Are you thinking of taking the next step and starting a venture of your own? While you plan your business strategy, the first step is to research the business loan, its interest rate and the source to get the loan. Don’t worry, we have researched for you and have analysed the various business loans that you can avail of for your venture.

What is a Business Loan?

A business loan is a fund lent out to a company for a specific purpose that would help to run the business. It could be capital to start a business or funds to meet operational expenses. The loan is available to sole proprietors, privately held companies, partnership firms, self-employed persons as well as small and medium shopkeepers.

There are several sources to apply for a loan. Lenders are willing to give loans as long as you pay them back on an agreed schedule, with interest.

Types of Business Loans

There are several types of business loans available globally. We are listing the ones available in India.

  1. Working Capital Loan – It is the loan given to businesses to meet their operational expenditures. Owners can use the fund to pay salaries and vendors or to purchase inventory and stocks. This is generally a short-term loan and hence interest rate is high. The amount of loan taken is generally up to Rs. 40 lakh payable within 12 months.
  2. Term loan – A business term loan is availed for a pre-defined period and may be unsecured or secured. The repayment tenor ranges from 12 months to 8 years, depending on whether the term is short, intermediate, or long. The amount for collateral-free business loans can go up to Rs. 2 Cr.
  3. A business line of credit – It is a revolving credit where you can take out funds as and when you require within the limit predecided by the lender.
  4. Equipment Finance or Machinery Loan – Equipment finance is used mainly by large enterprises majorly engaged in the manufacturing sector. If you are availing of equipment finance or machinery loan you can also enjoy tax benefits. The interest rate, loan amount, and repayment tenure offered vary from lender to lender.
  5. Point-of-Sale (POS) Loans – To reduce the cash crunch in your business, you may avail of the POS loan which comes at a steep interest rate as it is for a very short period.

Now that we know of business loans and the various types, let us look closely at the prevailing interest rates.

Business loan interest rates

Business loan interest rates are generally of two types – Diminishing Rate of Interest and Flat Rate of Interest.

a. Diminishing or Reducing Rate of Interest – The loans that you take are repaid in equal instalments called equated monthly instalments – EMI. The amount of EMI depends on the principal amount of the business loan, the rate of interest and the tenure of the loan. In this method of ROI, the interest is payable for the outstanding amount of the loan for each month. It means the interest keeps on decreasing as the tenure progresses and the loan is regularly repaid.

The formula for calculating the rate of interest for the Reducing Balance Method is

Amount of interest for each instalment = Applicable rate of interest * Remaining loan amount

Let us explain with an example. If you take a business loan of Rs. 10 lakh at a 10% interest rate, for a 5-year tenure, then the EMI amount would decrease with every month’s repayment. In the first year, you would pay Rs.10,000 as interest on your principal. But in the 2nd year, you would have to pay Rs. 8,000 only for interest as the principal amount has now been reduced. This is a simple calculation to explain, in reality, the interest portion varies every month.

b. Flat Rate of Interest – The other method to calculate your interest component is the flat method. The interest amount is predetermined in the beginning and you would have to pay the same amount throughout the tenure. This interest amount is significantly higher than the diminished interest.

The formula for calculating the fixed rate of interest is

Amount of interest for each instalment = (Original Loan Amount * Number of Years * Interest Rate per annum ) / Number of Payments.

In the previous example, the interest amount was decreasing with every payment. But in this method, you would have to pay a flat Rs.10,000 every year as interest.

The business loans interest rate broadly ranges between 15%-24% p.a. The final rate of interest is dependent on various factors like the borrower profile, credit score, financial statements, business stability, industry outlook and various other risk assessment parameters.

Facts on Business Loan

We have collated the salient features of a loan by comparing all the available options in the loan market today:

Loan AmountRs. 50,000/- to Rs.50,00,000/-
TenureMinimum of 12 months to a Maximum of 120 months
Business Loan Interest Rate10% to 21%
Loan Processing Charges2.50% of the loan amount subject to a minimum of Rs. 1,000/- & Maximum of Rs. 75000/-
PrepaymentNo pre-payment can be done until repayment of 6 EMIs
Pre-payment chargesUp to 4% on the remaining amount
Charges for late payment of Business loan EMIUp to 3% per annum on EMI / Principal overdue

Top factors affecting the business loan interest rate

Finally, let us look at the top factors affecting the interest rate of a business loan. Please note, the rate of interest varies from borrower to borrower depending on each person’s financial credibility.

  • Credit score
  • Business experience
  • Type of Business
  • Revenue and Turnover
  • Collateral
  • Repayment History

All of these factors contribute to the rate of interest that you can bargain for yourself.

Hence it is of utmost importance to understand the various interest rates for different types of business loans.

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