How interest rates for business loans could affect your start-up business

When starting or growing a business, borrowing money is often part of the journey.

But the cost of that borrowed money – the interest rate – could significantly impact your business’s profitability and cash flow.

Think of interest as the fee you pay to borrow money.

It affects how much you’ll need to pay back each month and, ultimately, how much money you’ll have left to run and grow your business.

With rates changing frequently, the difference between a good and bad borrowing decision could be thousands of pounds in savings, or extra costs, for your business.

Read on to learn more about interest rates for a business loan, including how they work, how you could manage them effectively, and how they might impact your start-up’s finances.

What is an interest rate?

An interest rate is the percentage you pay in addition to the amount of money you borrow.

If you borrow £10,000 at 5% annual interest and repay the loan in full at the end of the year, you would pay the original £10,000 plus £500 in interest accumulated over the year.

There are two main types of business loan interest rates: fixed and variable.

Fixed interest rates stay the same throughout the loan term, meaning your repayment amounts will not change.

They’re predictable but might be higher than the current variable rate available when you agree to the loan.

This consistency could make budgeting easier and provide financial stability.

Variable interest rates can go up or down, typically following the Bank of England base rate.

While your repayments might decrease if rates drop, they could also increase if rates rise. 

This uncertainty might make it more difficult to plan financially.

Knowing the difference between these rates might help you plan repayment strategies and manage your start-up’s finances effectively, even as economic conditions change.

Business loan interest rates vary widely and could be from around 4% to 15% or more, depending on the product you choose.

The Bank of England Bank Rate explained

The Bank of England Bank Rate, often called the ‘base rate’, is the interest rate set by the UK central bank.
It influences how much high-street banks and other lenders pay to borrow money.

This rate is a key tool used to try and control inflation and ensure economic stability.

When the Bank Rate changes, it has ripple effects throughout the financial system.

If it rises, it becomes more expensive for banks to borrow money, and they often pass these higher costs onto businesses and consumers through increased interest rates.

If it lowers, borrowing becomes cheaper, potentially reducing the interest rates banks and lenders charge.

For small businesses, a higher Bank Rate may mean increased costs for existing loans and more expensive new borrowing.

A lower Bank Rate could reduce borrowing costs, encouraging you to invest in your business and expand.

Both of these outcomes may impact cash flow and financial planning, so you may want to better understand the Bank Rate’s impact to anticipate these changes and adjust your financial strategies accordingly.

How do interest rate changes affect my business?

Interest rate changes could directly impact your start-up in several ways.

Variable loans become more expensive when rates rise, leading to higher monthly repayments and potential cash flow challenges.

This may limit your ability to invest in growing your business or manage expenses.

However, falling interest rates might reduce borrowing costs, making loan repayments more affordable and freeing up capital to expand or make other investments.

Interest rates could also affect consumer behaviour.

Higher rates could reduce consumer spending, impacting your sales, while lower rates might boost consumer confidence and demand for your products or services.

How interest rates affect business loan costs

Interest rates significantly influence the cost of business loans.

The Annual Percentage Rate (APR) reflects the total loan cost, including interest and fees.

Some business loans use simple interest with fixed monthly payments, but some products could have ‘compounding’ interest, meaning you would pay interest on the outstanding balance, which would inclued any accrued interest.

For example, on a £10,000 loan at a 5% APR over five years, you might repay around £11,322, while a 10% APR could mean repaying approximately £13,202.

Rising interest rates may also make existing loans more expensive if the rate is variable, increasing monthly payments.

For example, if the Bank of England increases the Bank Rate by 0.5%, a £50,000 loan at a variable rate could see monthly payments rise from £500 to £525, depending on the lender’s terms.

These changes could affect new and existing loans, so it might be wise to fully understand how interest rates work when choosing the right loan structure for your business needs.

Comparing funding options

Starting a business may require careful financial planning, and choosing the right funding option could be crucial for financial success.
Here are some common funding sources you could explore:

• bank loans – traditional bank loans offer fixed or variable interest rates and, while they often provide substantial funding, they may require a strong credit history and collateral
• overdrafts – an overdraft allows for flexible, convenient borrowing up to a specific limit, but there are often higher interest rates and fees
• credit cards – business credit cards may offer short-term financing with flexible repayment options, but they typically have high interest rates that can lead to rapidly accumulating debt if not managed properly
• alternative finance – peer-to-peer (P2P) lending and crowdfunding platforms connect businesses directly with investors, but interest rates may vary based on the perceived risk and the platform used
• government-backed loan schemes – these loans offer competitive fixed interest rates, often with added benefits such as business mentoring and support.

You could consider a Start Up Loan, a government-backed scheme offering up to £25,000 at a fixed interest rate of 6%, plus 12 months of free mentoring.

Interest rates would be a key consideration when comparing your options, but they differ across products.

Bank and government-backed loans typically offer lower rates than overdrafts and credit cards, while alternative finance rates depend on investor risk assessments.

Beyond the headline rate, you might also consider other factors, such as upfront fees, early repayment charges, and whether the rate is fixed or variable.

Some options may also offer added value through support and mentoring.

This could be invaluable if you’re a start-up owner in the early stages of your business journey.

Carefully evaluating all the options available could help you make an informed decision.

Read our handy guide to the best business funding alternatives.

Strategies to reduce interest exposure

Interest exposure is the risk that changes in interest rates will increase the cost of borrowing or reduce the return on investments.

Managing interest exposure could be crucial for keeping borrowing costs down and maintaining your start-up’s financial health.

Give your start-up a financial health check.

Here are some tips to try to lower your interest costs:

• shop around and compare offers – lenders offer varying rates and terms, so comparing options may help you find the most cost-effective option
• improve your credit score – a higher credit score may qualify you for lower interest rates, reducing overall borrowing costs
• borrow only what you need – minimising the amount borrowed might help lower your interest payments
• consider fixed-rate loans – fixed rates provide stability, potentially protecting against possible rate increases over the loan term
• repay loans early if possible – paying off loans early may save on interest; however, it could be worth checking that the loan terms allow for early repayment without penalties
• use government-backed loan schemes – these often offer lower or fixed rates, providing more affordable borrowing options.

Being comfortable borrowing

As a start-up business owner, managing debt risk could be crucial to planning for success.

A key step could be to include loan repayments and interest costs into cash flow forecasts and business planning.

Try our cash flow forecast template.

Understanding how these expenses fit into your financial picture could help ensure your business is prepared for any financial challenges.

It is also essential to balance the need for funding with your ability to repay the loan.

Therefore it may be prudent to  ensure that your projected revenues comfortably cover repayments.

Developing good relationships with your lenders could also help you get more flexible loan terms and extra support when needed.

This is because lenders could be more likely to trust businesses they know well.

You can also seek guidance from independent financial advisers.

FAQs about interest rates for business loans

Issues around business loans and interest rates can raise many questions.

Here are answers to some of the most commonly asked questions.

Should I wait for interest rates to fall before borrowing?

Timing could be relevant, but you may not want it to be the main determinant in your decision.

You could consider your business needs and the current economic climate, as waiting for rates to fall might delay crucial growth opportunities.

Instead, you might focus on finding the best available terms to ensure your business can manage repayments.

Can I negotiate the interest rate on a business loan?

Yes, negotiating may be possible, particularly if you have a strong credit history and solid business plan.

Lenders might offer better rates or terms to secure your business, so it could be wise to shop around and use competing offers to negotiate the most favourable rate.

What happens if rates rise after I’ve taken out a loan?

If you have a fixed-rate loan, your repayments won’t change.

However, if you have a variable-rate loan, your payments could increase, which is why it could be wise to include potential rate increases in your financial planning to avoid cash flow issues.

How can I protect my business from interest rate fluctuations?

You could consider choosing a fixed-rate loan to lock in your interest rate and have predictable repayments.

Regularly reviewing your financial forecasts and maintaining a cash reserve could also help protect your finances from unexpected changes.

What should I do if I struggle to make loan repayments?

If you find it challenging to meet your loan repayments, talk to your lender as soon as possible.

They could offer solutions such as restructuring the loan or providing temporary relief options.

Getting guidance from an independent financial adviser could also help you explore other effective strategies to manage the situation.

Finding the best interest rate for a business loan

You could make smarter financial decisions for your start-up by being informed about how rates could affect borrowing costs.

Using comparison tools from platforms such as Go Compare or Money Supermarket could help you find a business loan with the best interest rate. 

Though bear in mind that you need to be aware of all the conditions attached to the loan.

For tailored advice, you might consider speaking to an independent financial adviser, who could provide guidance for your financial situation.

If you decide to look for a fixed-rate personal loan, find out more about a Start Up Loan for your small business.