There are plenty of reasons why a particular loan might be right or wrong for you. However, for many, the bottom line is cost. With an increasing array of funding options being made available to businesses, how can you ensure you get one at a low cost?
How loan interest rates work
For starters, it helps to understand how lenders determine the interest rate on a loan. Lenders typically use risk-based pricing to determine the rates at which they will lend.
What exactly is risk-based pricing? It’s the lender trying to measure the likelihood that their loan will be repaid in full. It’s anchored to several factors (both quantitative and qualitative) and might take into account some of the following:
- The applicant’s credit score
- The type of employment of the applicant
- The loan-to-value ratio of the collateral provided (this is only taken into account if you are applying for a secured or an asset-backed loan)
Using the above parameters, a lender might consider an applicant as low risk if the applicant has a high credit score, the applicant is in full-time employment (as opposed to temporary or contracted employment), and the loan-to-value ratio of the collateral provided is low. This would, in turn, translate to a low interest rate being offered.
Lenders will look into every individual case in detail, but it’s the applicant’s responsibility to prove to the lender that they are low risk and as a result able to comfortably pay each monthly instalment on the loan. If you can showcase this, then the chances are you’ll qualify for a low interest rate loan.
Ways to obtain a low interest rate loan
More than anything, improving your credit score is the best way to showcase that you are a low-risk applicant. A high credit score tells the lender about your credit history, which is a strong indication of what’s going to happen in the future.
So how can you improve your credit score? Something as simple as registering on the electoral roll can have a surprisingly positive effect as it proves where you live.
Looking to build your credit history can also have a positive impact on your credit score. It’s possible to be issued with a credit card that is specifically designed to improve credit scores. By being issued with a credit card, and managing this card properly, it shows lenders that you are trustworthy.
Visit this helpful article by Money Saving Expert for some more great tips on how to improve your credit history.
Affordability simply means the extent to which the applicant can meet and pay off the monthly repayments on their loan. The key driver of affordability is the applicant’s income. How a lender determines overall income will quite often depend on the type of applicant.
If the applicant is an individual, income will be assessed using a combination of their salary, rental income, pension income or investment income.
If the applicant is a business, income is usually assessed using the net profit of the business, i.e. “what’s leftover” to service the loan. The lender might make certain adjustments to net profit to better approximate the actual cash generated by the business.
Boosting your affordability can be hard — it’s not as if salary or profit increases happen overnight! But there are some tactics that you can roll out. The most popular amongst these is having a second applicant on your application. This could be a family member, business partner, or an extremely good friend. Having this second applicant on your application could make a real difference to your affordability, and as such your risk profile, and is well worth considering.
The majority of loans available to businesses are unsecured, meaning they are underwritten against the applicant’s credit score and affordability. Unless the applicant has an almost perfect credit score, the rate of interest on an unsecured loan is likely to be fairly high, starting at about 15% and going as high as 50%.
One way of reducing risk to the lender and in turn lower the interest rate on the loan is to provide collateral as security (usually something which holds its value, such as property or stock). By providing collateral to the lender as a security, the applicant significantly de-risks the transaction from the lender’s perspective. This is because if the applicant is unable to keep up with repayments, or defaults on the loan, the lender can take possession of the collateral to mitigate against any losses.
Loans that are secured come with much lower interest rates due to the lower risk. You might be able to get access to a loan with interest rates as low as 4.95%. Considerably cheaper than an unsecured loan.
About Selina Finance
At Selina Finance, we offer secured credit facilities for businesses and property investors. By securing our credit facility against your property, we are able to offer considerably lower interest rates and a more flexible financing option that allows you to manage your finances in a completely new way.
Interest in finding out more? Visit www.selinafinance.co.uk and get in contact with us.