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Before you obtain a business loan, one of the first questions that you will ask the lender is ‘What is the rate of interest?’. In fact, the rate of interest is one of the key factors that determine if you will take a loan from the particular lender. As such, it’s important that you understand how to calculate interest on a business loan as it will determine your monthly equated monthly installments (EMI).
More the interest rate, the more amount you repay over the tenure period. For example, if you compare business loan interest rates from two different lenders, all other factors remaining constant, the rate of interest will affect the overall amount you will have to repay. Higher the bank interest rate, higher the overall EMI you will have to repay. Therefore, it is important to negotiate interest rates with the lender while seeking a business loan.
Factors influencing business loan interest payable
The rate of interest is not the only factor that influences the overall business loan interest payable. Here are the factors that determine your EMIs and overall interest payable.
- Rate of interest: As mentioned before, higher the rate of interest on a business loan, the higher will be the overall interest payable considering other factors remain the same. Although the rate of interest is largely regulated by the Reserve Bank of India (RBI), the actual interest rate varies between banks and NBFCs. There are also other charges including processing fees, documentation fees etc. that adds to the overall interest payable.
- Loan amount: This is an important factor in the interest payable. A lower loan amount attracts lower overall interest while a higher loan amount attracts higher overall interest even if the rate of interest is the same. The loan amount depends on many factors including the need of the business, the credit score of the borrower, etc. As a borrower it is therefore recommended that you understand your financial requirements and borrow a sum that is required and not less or more.
- Repayment tenure: Tenure of the business loan is the third element that impacts the overall interest. The borrower pays more interest when the business loan is for a longer duration. Largely, there are two kinds of business loans available with the lenders – short term business loans and long term business loans. Short-term loans are usually for smaller amounts (usually up to ₹1 crore) and for a short duration (usually 3-5 years). Long-term loans are for higher sums (can run into crores) and for a long tenure (e.g., up to 10 years).
All these factors together impact the interest rate on business loans and the sum you will be repaying to the lender as EMIs every month.
How to calculate interest on business loan?
In order to calculate interest on a business loan, one needs to calculate EMI. Here is a formula to calculate EMI on your business loan.
EMI = P x r x (1 + r)n / (1 + r) n-1
P= Principal amount i.e. loan amount
r= Rate of interest per month
n= repayment tenure in months
Now, if your loan amount is ₹1 lakh, the rate of interest is 20% and the repayment tenure is 4 years. Then the formula works as below:
Interest rate per month comes to 20/12= 1.66% while tenure in months come to 4×12 = 48
EMI = 1,00,000 x 1.66/100 x (1 + 1.66/100) / (1 + 1.66/100) 48-1.
Your EMI will be ₹3043
When you repay ₹3043 every month for 48 months, your overall stands ar: ₹146,064. The formula is given below:
3043×48 = 1,46,064
Now we come to the main question of how much interest you will pay. When your principal amount i.e. loan amount is ₹1,00,000 and you repay ₹146,064 by end of your tenure, you pay an overall interest of ₹46,064. Below is the calculation for the same:
146,064 – 100,000 = 46,064
Now, doing such an intense calculation manually is a tedious task. For ease of calculating interest on a business loan, many lenders such as ICICI Bank, HDFC Bank, etc., have business loan EMI calculators to simplify the calculation.
Using EMI calculator
While getting a business loan, it is important to take an informed decision. Therefore, these EMI calculators help you to compare various offers.
- Always get in touch with more than 2 lenders, so that you can compare offers and choose the best loan offer.
- It is important to calculate the rate of interest on each offer and compare EMIs before accepting any offer.
- Not all lenders have similar rates of interest. The interest rate has a direct impact on the interest payable. For example, the total interest payable on a loan amount of ₹1 lakh at 20% for 4 years is ₹46,064. While total interest payable on the same amount for the same repayment period at 18% comes to ₹ 41,000 and EMI is reduced to ₹ 2,937.
- Often borrowers prefer a business loan with lower EMI. However, one must remember that lower EMI and longer repayment tenure results into higher payable interest.
Tips to obtain a business loan
- A business loan can be obtained online and offline. Often, loan schemes offered online and offline are different. You can explore both options. Check eligibility criteria, documentation, collateral requirement, etc., before applying.
- Compare the approved loan amount, rate of interest, repayment tenure and other terms and conditions, if they are favourable to you. Often banks have specific loan offers for entrepreneurs such as loan offer for a business in the tourism industry, loan for a traders, etc.
- The Government of India has launched several schemes for fostering the growth of MSMEs such as Stand-Up India, etc. Do explore government loan schemes too as they often have a lower rate of interest.
- The rate of interest and interest payable are not the only elements to determine if the loan offer is the best one for your business. Approved loan amount, processing fees and other charges involved, repayment tenure, etc., are also important factors while finalising an offer.
- Once you have finalised which loan offer to accept, read the business loan agreement.
- Beware of the business loan scams. Be careful while you reveal your information.
- Also, beware of myths regarding business loans. For example, it is a common misunderstanding that all business loans need collateral. Collateral free business loans are also available.
Suitability of loan differs from a business to business. For example, an entrepreneur may have a collateral to promise while others may not have. Also, business loans from institutions like SIDBI can come at lesser interest rates than private banks and NBFCs.
Also, remember to check alternative funding options like micro finance loans and bank overdraft facility.
As result explore all options and select the one best suited for your business.