How business loans work, and how much you can borrow
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Key takeaways
- Your payment depends on three things: how much you borrow, the interest rate, and the term. A longer term lowers the payment but raises the total interest.
- Compare loans by APR, which adds upfront fees to the interest rate. Fees can make a low-rate loan cost more than it looks.
- Lenders size your loan with your DSCR: net operating income divided by yearly debt payments. Many want at least 1.25.
- The interest is usually deductible if you use the loan for your business. The principal isn’t.
- Watch out for factor rates. Short-term advances quoted as a factor rate can cost well over 50% a year.
How the business loan calculator works
| Input | What to enter |
|---|---|
| Loan amount | How much you plan to borrow. |
| Interest rate | The yearly interest rate your lender quotes (not the APR). |
| Loan term | How many years you have to repay it. |
| Upfront fees | Origination, packaging, or guarantee fees. The calculator uses them to find your APR. |
| Extra monthly payment | Anything you plan to pay on top of the required payment each month. |
It assumes a fixed rate and equal monthly payments, which is how most term loans and SBA loans work. You get your monthly payment, first-year interest, total interest, total cost, and a year-by-year schedule.
Let’s see an example
Say you borrow $50,000 at 10% for 5 years. Your monthly payment is $1,062, and you’ll pay $13,741 in interest over the life of the loan, for a total of $63,741. About $4,635 of that interest comes in the first year.
Add $200 a month on top, and you’d pay it off 11 months sooner and save $2,806 in interest. Check that your loan has no prepayment penalty first.
How much business loan can I get?
Lenders look at your credit, how long you’ve been in business, and your collateral. But the number that usually caps the loan amount is your debt service coverage ratio (DSCR): how many times your profit covers your yearly loan payments.
DSCR = net operating income ÷ yearly debt payments
Net operating income is your revenue minus the costs of running the business, like payroll, rent, and supplies. Leave out loan payments, which go on the bottom of the ratio, and tax-only deductions like depreciation or the home office deduction.
How much can I borrow?
Based on a 1.25 debt service coverage ratio, a common lender minimum.
A DSCR example
A business brings in $60,000 a year and spends $44,400 running it, so its net operating income is $15,600. It already pays $500 a month on a van loan and about $250 a month on a business credit card, or $9,000 a year.
- Its DSCR today is $15,600 ÷ $9,000 = 1.73. It earns 1.73 times what it owes in loan payments each year.
- At a 1.25 minimum, its total yearly debt payments can be up to $15,600 ÷ 1.25 = $12,480.
- Subtract what it already pays, and there’s room for $3,480 a year, or $290 a month, in new payments.
- At 10% over 5 years, that payment supports a loan of about $13,649.
Lenders set their own minimums, and some SBA lenders accept less than 1.25. Raising profit or paying off existing debt is the most direct way to qualify for more.
Business loan interest rates
Bank and SBA loan rates are usually set as the prime rate plus a margin. The prime rate moves with the Federal Reserve’s rate decisions; it has ranged from 3.25% to 8.5% over the past decade, and the Federal Reserve publishes the current rate. Your margin depends on the lender, the loan type, and how risky your business looks to them.
- SBA 7(a) loans cap how much lenders can charge above the base rate, with higher caps on smaller loans. They go up to $5 million, with terms of up to 10 years for working capital and equipment and up to 25 years for real estate.
- SBA microloans go up to $50,000 through nonprofit lenders, and are often easier for newer businesses and freelancers to get.
- Online term loans are faster to get but usually charge more, often with origination fees.
Fixed or variable rate?
A fixed rate keeps your payment the same, which makes budgeting easier and protects you if rates rise. A variable rate moves with the prime rate. It can start lower and save money if rates fall, but your payment goes up if they rise.
Factor rates: read the fine print
Merchant cash advances and some short-term online loans quote a factor rate instead of an interest rate. A factor rate of 1.3 on $20,000 means you repay $26,000. That sounds like 30%, but if you repay it over 6 months, the APR is about 97%. Always ask for the APR before you compare.
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Is business loan interest tax deductible?
Generally, yes. Interest on money you borrow and use for your business is a deductible business expense. If you’re a sole proprietor or single-member LLC, you deduct it on Schedule C, which lowers both your income tax and your self-employment tax.
- It’s about how you use the money. The IRS traces the loan to what you spend it on. If you use part of a business loan for personal expenses, the interest on that part isn’t deductible.
- Principal isn’t deductible. Only the interest is. What you buy with the loan, like equipment, may be deductible or depreciable on its own.
- Loan fees like origination fees are generally deducted over the life of the loan, not all at once.
- The business interest limit rarely applies to small businesses. It only kicks in when average yearly gross receipts are in the tens of millions.
The calculator shows your first-year interest, which is roughly what you’d deduct in year one. Other interest can count too, like on a business credit card or the business share of a car loan.
What you’ll need to apply
- Your business’s tax ID: an employer identification number (EIN), or your Social Security number if you’re a sole proprietor without one
- Business and personal tax returns, usually for the last two to three years
- A profit and loss statement and balance sheet, plus recent bank statements
- A list of current business debts
- A business plan showing how you’ll use the money, for larger or SBA loans
- Formation documents if you’re an LLC or corporation, and details on any collateral
Check your personal and business credit reports before you apply and get any errors fixed. Then get quotes from a few lenders, starting with the bank you already use, and compare them by APR.
Can freelancers get a small business loan?
Yes, but lenders will look mostly at you. Without a long business credit history, they rely on your personal credit score and your income history, usually from your last two years of tax returns. That makes clean records important: keep business spending in a separate account if you can, and track your income and expenses all year so you can show your profit when a lender asks.
If a bank loan isn’t a fit, other options include:
- SBA microloans
- Business credit cards, for smaller, short-term needs
- Personal loans, though you’re personally on the hook
- Grants and crowdfunding, which you don’t pay back
7 sources
- SBA: 7(a) loans · sba.gov
- SBA: 7(a) loan program terms, conditions, and eligibility · sba.gov
- SBA: Microloans · sba.gov
- Federal Reserve H.15: selected interest rates (bank prime loan rate) · federalreserve.gov
- IRS: Instructions for Schedule C (Form 1040) · irs.gov
- IRS: Questions and answers about the limitation on the deduction for business interest expense · irs.gov
- IRS: Get an employer identification number · irs.gov
This article is for informational purposes only and isn’t tax, legal, or financial advice. Tax rules change and depend on your situation, so talk to a tax professional about yours.
By Christian Davis
