When High Interest Rates on a Loan Make Sense

Posted at 08:37h in Small Business Financing by Kelly Hillock

High interest rates on a business loan could mean faster approvals, no collateral requirement, or shorter payback periods. The interest rate is controlled by a combination of the level of risk taken on by the lender and the convenience they are offering to the borrower.

If you’re worried about the interest rate on your loan being too high, here are a few situations where the overall situation could still be beneficial to you.

Each of these could also become strategies that can help you get a lower interest rate if you’re open to sacrificing some of the perks that a high-interest-rate loan offers, like the speed of the approval process.

Speed

If your business needs funds quickly, a lender may be able to speed up the approval process by offering a higher interest rate. If your core financial track record shows net positive financial statements over multiple years and a strong business credit score, and your assets for collateral are strong, you lower your risk level and can get a faster approval. But expediting the process incurs additional costs for the lender, which are then passed on to you.

This is a benefit as you’ll get your financing when you need it, which is especially important for emergency business loans, payroll, and working capital needs.

The speed benefit also helps companies like manufacturers that have gotten an unexpected influx of orders from a new customer and now have to produce products before a tight deadline. By paying the higher interest rate, you can secure the materials needed to make the product and keep your lucrative new contract, while looking for a lower rate on the next loan once the need for fast financing is over.

Length of the Loan

Short-term business loans mean fewer interest payments and less money for the lender, so the lender often increases the interest rate to make up the difference. Even at a comparable cost, there can be benefits to taking out a shorter-term loan. The shorter payback period erases the debt more quickly from the credit bureaus, which can be good for your business credit score.

By having a better business credit score, you’ll have a better chance at securing more financing in the future, because there is less risk involved.

Payback Period

To protect the profitability of their loans, lenders can include early payment penalties and restrict full repayment until later in the loan’s term. Shorter-term loans are already less profitable due to the length, so the early payment penalty helps prevent a further reduction in revenue for the lender.

This can work in your favor when you are using the financing for equipment that will significantly increase your revenue and leave you in a good position to pay the loan off early. Despite a higher initial interest rate and potential prepayment fees, by settling the loan early, you are cutting the number of interest payments and reducing the overall cost of your borrowing.

Low Monthly Payments

Some high-interest financing options offer longer repayment terms. By opting for a higher interest rate paid off over a longer term, you can reduce your monthly payments. While this can significantly increase the total cost of borrowing, it may be a good idea when you cannot afford a larger monthly payment due to tight cash flow. However, in most situations longer-term loans with high rates won’t be beneficial in the long run due to their higher cost.

The table below shows how extending the term can impact the regular payments and the interest paid over the life of the loan.

Principal	Term	Interest rate	Monthly payment	Interest over the full term
$100,000	5 years	6.0%	$1933	$15,997
$100,000	6 years	6.5%	$1681	$21,031
$100,000	7 years	7.0%	$1509	$26,779

Fees

While the interest rate is the headline cost of a loan, some lenders will also charge fees that may not be immediately obvious, such as service or administration fees. The lower interest rate could be a way for the lender to be more appealing to potential borrowers as they shop around, while these same lenders recoup the lost revenue from the cost of hidden fees. Meanwhile, other lenders, even if they have higher rates, don’t charge hidden fees and provide a more straightforward breakdown of costs. So, be sure to ask about additional fees before locking in financing.

Bad Credit or No Established Business History

If you have a bad credit score, or your business is so new that it doesn’t have a track record, you will be considered a higher-risk borrower and charged a higher interest rate. The high interest rate loan gives you access to funding that you otherwise wouldn’t be able to secure.

As your risk level decreases over time, you will likely be able to get a better rate, so don’t let the high one in the beginning deter you from getting further financing to grow your business in the future.

Not Enough Assets for Collateral

Securing a loan with collateral gives a lender security as they will be able to sell it off and recover their losses if you default on the loan. The more collateral you provide, the lower the risk, resulting in a lower interest rate. Meanwhile, an unsecured loan (loan without collateral) is a higher risk for the lender but lower risk for you since you have less to lose, so the lender makes up for the added risk with higher interest rates.

If you don’t have enough collateral to put down, or a glowing track record and business credit score, the higher interest rate may be the tradeoff. By not taking the higher interest rate, you may not get the funding, which is why it is a benefit here and not necessarily a negative.

The lender is likely going to require a UCC filing, so make sure they list specific assets to identify specific equipment and not generic wording like “commercial kitchen equipment” or “machinery.” By requiring the lender to be specific in their UCC filing, if you default, they can only access specific assets and not everything that could be considered “machinery.”

Situations Where Loans With High Interest Rates Can Help Your Business Grow

Outside of the speed and monetary benefits of a high-interest-rate loan, there are times where they can help grow your business.

Competitive Real Estate Purchases

When trying to secure a deal in an area where properties go fast, you can’t afford not to have funds available immediately. Whether it is a sought-after new retail location or a property selling under market value following a foreclosure, fast financing like a bridge loan with a higher interest rate can help you get the deal done before anyone else. Once secured, you can get a long-term loan at a lower rate to pay off the first loan.

Business Critical Problems

If you’re faced with an unexpected emergency that is going to stop your business from operating, you may lose out on sales and lose valued customers. The cost to replace a large account may be significantly higher than paying a high interest rate. Whether it’s a cash flow problem or equipment failure, a fast loan can stop a temporary hiccup from becoming a much bigger problem.

Peak Periods

Demand for a product can spike and require you to act fast. Because quick approvals normally mean higher interest rates, you may want to just accept the rate because the higher demand and increased revenue for your products will more than make up for what you pay to the lender.

If you sell cooling products like air conditioners or fans and there are unexpected heatwaves, this could be the perfect time to take this kind of loan, as demand will spike and you’ll recover the costs. The same applies when an item becomes the go-to product for the season or year. Going viral causes demand to spike, and if you don’t act fast to get funding and increase production, you lose out on the revenue you could have made with customers lining up.

Higher interest rates are not always a bad thing. They can speed up the application process so you do not miss out on a deal, get you financing when it normally would not be available, and provide you with relief to cover expenses and keep operations running smoothly amid emergency situations.