Businesses often need loans. They can use the debt to support operations, purchase inventory, buy new equipment, open new locations, renovate existing locations, or even buy out competitors. Once they take the loan, they are required to repay the lender the principal plus interest. Hence, low-interest loans are much more preferable to businesses than high-interest loans.

There are many factors that guide lenders in determining the amount of interest to charge a business for a loan. They are broadly split into two areas: individual and market factors.

Individual factors relate to the business itself. The first of these is cash flow. Cash flow is the amount of cash going into and out of a business. A business with good cash flow has plenty of money moving through it every week with more money coming in than leaving, meaning the business is profitable.

This is why lenders ask for bank statements from loan applicants - to analyze their cash flow. The higher the income versus expense payouts, the more stable a business looks to a lender and the lower the interest rate the lender will charge. Little cash flow or more expenses than income indicate to lenders that the business is not stable, hence they are likely to charge higher rates.

The borrower’s credit worthiness is another individual factor. Borrowers with credit scores of 700 and above are viewed as creditworthy and can qualify for low rates. Those with credit scores of below 580 are considered high risk, so borrowers will charge them higher rates.

Collateral is an equally important consideration. Lenders prefer loans secured by collateral (a valuable asset the borrower owns such as real estate or a vehicle). If a borrower pledges collateral as security, lenders will be more inclined to offer lower rates, as they can take possession of the borrower’s property in case of default. The greater the value of the collateral compared to the loan amount, the less risky the borrower is.

The age of the business and financial history also play roles. Established businesses with a long history of operations and meeting financial obligations are considered less risky by lenders. On the other hand, startups with very limited financial history may be viewed as risky.

Loan amounts and duration are factors, too. Lenders may view large loans as higher risk than smaller loans, charging higher rates for them. They may also view long-term loans as riskier than short-term ones, as they are more exposed to economic and industry fluctuations.

Market factors, on the other hand, are those factors that businesses do not have control over. They include Federal Reserve monetary policy, industry changes, and government policies. If the Federal Reserve raises interbank lending rates, then banks will likely raise rates charged to borrowers. If the Federal Reserve lowers the rate, banks will lower theirs too. Industry changes such as technological disruptions may lead lenders to look at certain industries as riskier, while government policies that incentivize lending will encourage banks to lend at lower rates.

With this understanding, business owners who want to qualify for lower-rate loans can plan accordingly to reduce their perceived risk to lenders. For example, they can improve their credit scores by paying their debts and bills on time every month and demonstrate financial stability by preparing accurate records and showing consistent healthy cash flow accounts.

Other actions they can take to lower their interest rates are pledging collateral, paying off existing loans, establishing long-term relationships with lenders, and choosing shorter term loan structures. Borrowers can also shop around for lenders with lower rates and negotiate with them to lower them further.

Keeping an eye on market developments is an extra step borrowers should take. If the Federal Reserve indicates it will lower interest rates, borrowers can prepare to take a loan or refinance an existing high-rate loan.