The low-down on low interest rates: Are they really the best value?

Henry Baker

Tuesday, 02 March 2021

Comparing rates from several lenders with a fine-tooth comb isn’t practical for most business owners, especially when you need to account for things like fees, ongoing costs, and hidden T&Cs in the fineprint. Life is busy enough as it is.

This quick guide covers all the important things you need to know to get the best rate (and the most value) for your business. We also offer a free personalised review of rates from 80+ lenders, so if you’re short on time, jump over to our loan finder and get yours.

How do business finance interest rates work?

Loan repayments consist of two portions—principal and interest. The principal is the amount you borrow.

For example, let’s say you borrow $50,000 from a bank. You’ll pay the $50,000 back over time, and in addition, a fee (interest) in exchange for borrowing funds.

This is how your lender makes money, and it’s also to help mitigate risk involved in lending to you. The amount of interest you pay over the course of your loan varies depending on the Reserve Bank of Australia cash rate, the array of risks associated with lending and the term of your facility.

Let’s explore this further.

How is my monthly interest payment calculated?

Lots of factors influence how much interest you’ll pay each month, including how long you’ve been in business, the industry you’re in, the market and the stability of your sales. There are a number of ways in which lenders communicate the interest rate:

1. Factor rate

The factor rate is expressed as a decimal. For example, 1.2 is equal to 20%. If you were to borrow $150,000 with a factor rate of 1.2, you’ll end up paying $180,000 with interest included. You can work this out by multiplying your factor rate by the total amount you’re borrowing.

The factor rate does not take your loan term into account, it simply expresses the total interest percentage over any given term.

2. Total interest percentage

This is similar to the factor rate. However, rather than being expressed as a decimal, the total interest percentage (TIP) is expressed as a percentage (%). The TIP percentage is usually expressed as a % p.a. (therefore annually) or the total interest percentage over the course of the term.

3. Annual percentage rate (APR)

There are a number of ways to calculate the APR of a loan—the simplest would be to use the payment formula on excel (PMT). The APR looks at the principal balance you owe per year, and expresses the annual interest rate charged on this amount.

This is how financial institutions communicate the rate of interest on most facilities such as mortgages, credit cards and loans.

The APR is a higher figure as it expresses the interest charged on the reducing principal balance, whereas the total interest percentage per annum expresses the interest charged on the total principal. Here’s an example:

If you borrow $100,000 over 12 months at a 19.95% APR, your monthly payment would be $9261.06.

If we multiply $9261.06 by 12, we get $111,132.69.

So, to work out the total interest percentage we divide the total interest $ component ($11,132.69) by the total principal ($100,000). This equals 11.13% p.a. (rounded to 2 decimal places).

What factors impact your interest rate?

Loan amount

The amount you borrow, as well as the type of facility and loan term, will largely determine what your interest rate will look like.

Generally, the more you borrow and the longer your loan term, the lower your interest rate. These are typical characteristics of secured finance. On the other hand, unsecured finance usually comes with shorter loan terms and higher interest rates.

Across all lenders, absence of security is synonymous with a higher level of risk. That’s why some financiers (such as nonbank lenders) will charge a higher rate over a longer period of time. For example, the annual percentage rate might be 13% p.a. over three years or 15% p.a. over five years.

Your credit score

A healthy credit score and history prove you’re responsible with finances, making you less of a risk to your lender. If your credit score is considered ‘excellent’, you’ll likely score a lower interest rate.

The current market/economy

You can expect higher interest rates in a booming economy. On the other hand, it’s common for interest rates to drop significantly in a recession.

The health of your business

Lenders will want to see your financials to get an idea of how your business is performing. The better things look, the better your interest rate (or at least, that’s what you can expect). Typical areas of interest on financials include gross profit margin, profitability, current ratio, quick ratio and net tangible assets.

Your trading history

If your business has been around for a long time, this is a great sign. Length of time trading is one factor that can prove the stability of your business, and this tells lenders you’ll be less likely to default on your loan and more likely to pay on time and in full.

Your lender

Just like shopping for a house or car, rates on business finance vary depending on where you look. Bigger banks usually offer lower interest rates, as their cost of capital is lower and they have stricter approval criteria. This is also why they only accept lower risk customers.

Smaller fin-techs and non-bank lenders, on the other hand, tend to offer higher interest rates in exchange for more lenient approval criteria. They also offer a shorter application process and in some cases, greater flexibility.

Terms and conditions outlined in your contract

Remember to read the fineprint and take into account all fees, terms and conditions—not just the interest rate. You might be offered a rate that looks too good to be true, later to find ongoing fees you didn’t plan for or less flexible terms that don’t suit you.

Fixed or variable interest rates

Fixed interest rates are locked in, so you know exactly what you’ll be paying over a set term. This is great if predictability is important to you. You won’t have to worry about interest rates soaring if the market turns, but at the same time, you won't reap the benefit of lower interest rates.

If you’re on a variable interest rate, your repayments will change with the market. There are pros and cons to both fixed and variable rates. Speak with a lending expert to determine which one is best for you.

Collateral

Collateral is used to reduce your risk as a borrower. It’s an asset (usually a property you own) secured against your loan. Your lender will determine the value of your property at the time of application, and then use it as a last resort to pay for any losses incurred if you default on your loan.

Can interest rates ever drop to zero?

While rare, interest rates can drop to zero or even become negative. This does not mean your loan will incur zero interest, rather it means that the Reserve Bank of Australia sets a target for the cash rate at 0%.

This means that banks are able to borrow money at a lower interest rate and pass these savings onto borrowers. However, the cost of lending still exists.

For example, banks need to pay their staff to process loan applications and cover operating overheads, while nonbank lenders need to pay back their capital provider at a premium.

Does the lowest interest rate always mean the best value?

In short, no. A low interest rate isn’t always the cheapest option. While lower rates are usually more favourable, watch out for terms and conditions associated with your loan that might impact the total price you’ll end up paying.

For example, some finance products offer a low interest rate that looks attractive at first, but when you dig deeper you might find an expensive application fee, ongoing monthly fee, early termination fee or other conditions that could be problematic down the line. And while certain T&Cs might be okay, others mightn’t be ideal for your situation.

Here’s an example.

Let’s say you take out a business loan with an interest rate of 4.5%. You find that this rate is low compared to the other options you’ve considered. However, this option also comes with an upfront one-off fee of $850, and an ongoing monthly fee of $10.

While the first option intially seemed more attractive, the second option is actually $766 cheaper.


Missing important details in the fineprint is an easy mistake.

The great thing about speaking with a lending expert is the peace of mind that comes with knowing exactly how much you’re paying, and for what.

You can chat to a lending expert at no cost, to find the best finance solution for your needs—interest rates, fees, terms and conditions all taken into account and compared against products from 80+ lenders. This way, you can breathe easy knowing you’ve scored a genuinely great deal.


Henry is a Senior Product Specialist specialising in working capital solutions. He loves helping entrepreneurs achieve their growth goals and getting to know their businesses in-depth, in order to find the most fitting product for their needs.

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