What will my business loan rate be?

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Transcript

This next lesson, we're going to talk about loan rates. And this is one of the most common questions that you get when you work with someone looking to seek a business loan, if you're a broker, or someone like myself that's been in the industry is what is it going to cost me to borrow this money in the first place. And it's just not as easy as it used to be where bankers or lenders have a matrix that they follow, and they can tell you exactly what it's going to cost you. So I want to talk you through how to figure out what your loan rate may be, and maybe even talk a little bit about some ways to reduce your loan. Right. So how our loan rates set well, loan rates are typically associated with what is called a risk grade and is a grade that a lender assigned your loan and they use that grade to determine what your rate may be.

And again, it's not a matrix, where they say, okay, you want this much money for this long and it's 5% like it is with a car loan. It's a little bit different, and they come up with this risk rate. Now the risk rates are based on a variety of factors, probably too many for me to go into, but you can imagine what some of them are It's gonna be things like your credit score, your debt service coverage ratio, what collateral you're offering, and how long the loan is going to be those types of things go into a risk rate, and then they use that risk rate to determine the rate. The other thing that is built into this is lenders have a cost of funds, they are loaning out money that they've either either taking in from their customers or members through deposits, maybe they are borrowing money to then turn around and lend money out.

Maybe they've raised venture capital money as a lot of the peer to peer lending folks have done so anyone who's lending money typically has some sort of cost of funds associated with the money that they're going to be lending out and what the cost of funds is, is just what it sounds like. It's what it costs them to get that money to then turn around and be able to lend out. A simple example of cost of funds is if your bank is paying 1% on savings accounts. If they use those cumulative dollars and alone, those out then their cost of funds their basis of cost of funds for that A particular portion is that 1% that they're paying people to bring the deposits in, what they do is your traditional lenders will take their cost of funds, or the index that they're on, and then they will add a margin, they will add a margin.

And so those margins are usually tied to some sort of index. So what are the most common indices? Well, the most common one would be the Wall Street Journal prime rate, they may use that they may use a 10 year Treasury rate, and then add a margin to it. In days gone by is sort of starting to end now. But they a lot of bankers used to use what's called libre, which is a London index, and they take whatever that is at that time, and then add a margin to the amount so let's say for example, The Wall Street Journal prime rate, I'm not even sure what it is today, but let's say it's at 5%. If that's their basis for the rate, and then they take your risk rate and if your risk rate is say riskier than someone else's, they may add another 4% to that 4% plus the five percent on the Wall Street Journal prime rate would mean your rate would be 9%.

If your risk grades a little lower, and the margin says that should be one and a half percent on top of the wall street journal prime rate 5% on Wall Street Journal prime rate plus one and a half percent margin, or extra is six and a half percent. So if you at least follow these indices before you talk to a lender, you'll have at least a basic idea of what the starting rate is probably going to be. And it's perfectly okay for you to ask a lender, what's the indices that you tie your rates to, and then you can go research that ahead of time, if they use the Treasury rate, go look up with the 10 year Treasury right is if they use a five year look it up. If they still use live board, look it up and see what it's going to be.

So just understand that there's a cost of funds that they have with these loans. The lower their cost of funds, the the more aggressive they can be with their rates, and they're going to have an industry that they tie your loan to and then they're going to add a margin on top of it. Okay, so um, there's a couple Ways to negotiate a better rate. And the point I just made was to know what how rates are set in the first place. So instead of waiting until you're approved for a loan, when you have that first conversation, ask the lenders representative, how do you set your rates? What industry do you use?

Do you add a margin? Is that something you can share with me? What goes into my risk? Right? Those types of things, ask these questions. They may not tell you all of them.

But the more you know, the better chance you have in negotiating your right. If you know they're going to type to The Wall Street Journal prime rate, maybe you can ask if you can have it as a variable rate so that when that goes down, your rate goes down. So I understand the indices asked about the risk grade. The other key way to negotiate a better rate beyond just knowing how it's set in the first place, is to understand what lenders are looking for. Lenders, if they take deposits, or any other offer any other types of services are often interested in relationships. They're very relationship focused particularly traditional banks and credit unions.

So if you offer To use one or more of their other products or services, oftentimes you can negotiate a discount. In fact, oftentimes, those lenders will flat out tell you that if you bring your deposits to them, let's say you have a payroll account, and all your money for your payroll goes in there and sits there to the end of the month, if you tell them if the lender will oftentimes say, hey, if you bring over that account, with a minimum balance of XYZ, we'll give you a quarter percent discount on your loan. So know that you can offer to bring multiple services or products over to that new relationship or even switch over to an existing relationship and oftentimes negotiate a better rate. Another way to negotiate a better rate is to offer some sort of collateral. We've talked about collateral, we've talked about loan devalues talked about secured and unsecured loans, secured loans definitely get better rates than unsecured loans.

And so if you were going to go the unsecured route, maybe offer to give some sort of collateral, if you feel like you want to use that you're willing to use that collateral to negotiate a better rate. And then also on a variable rate loan alone whose rate can change depending on how the industry industry, the index rate changes, is to ask for a rate ceiling. So a lot of people don't know that you can ask the lender to set a maximum amount, but the loan can go up to over time. So let's go back to that example. Let's say your lender uses the Wall Street Journal prime rate, let's say it's 5%, they're going to add a margin of 3%. They're going to put you at 8%.

You might could negotiate Hey, how about a rate ceiling of 10% over time, so the most alone could go up would be 2%. If the Fed raises the Wall Street Journal prime rate, they raise it a quarter percent, your loan will go up a quarter percent until it maxes out at that rate ceiling. So that's another thing you can do with variable rate loans. If it's a fixed rate, there's no need your fixed your rate should be set for the term of the loan, not the amortization of the loan. Keep in mind those differences. So then the day what it really means When it comes to rate, it's not easy to negotiate the rate itself unless you have offers from other lenders.

I have seen people use those to get better rates but know how rates are set and offer some of these things, other products, services, collateral, all those things to negotiate a better rate. Even if you only get a quarter of a percent point two 5% off of your loan. It can really add up if you look at these examples on a million dollar loan, you can save over 2500 bucks per year doesn't sound like a ton of money but over a 10 year loan you just saved yourself $25,000 so know how rates are set, offer multiple services, negotiate ceilings, and and try and drive that rate to a more competitive area. Just walking in without having done your research on any of this is going to cost you more in the long run.

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