FAQs – What’s The Interest Rate?
This week we’re continuing our series of blogs around what we call FAQs – Frequently Asked Questions.
In our years of working with clients, we’ve discovered that the same questions get asked on a regular basis.
So, over the next few weeks, we’re answering some of the most commonly asked questions that we get from clients and prospective clients.
We continue this week with FAQ number 2.
If only we had a pound for every time this question gets asked!!
The question is:
What’s the interest rate?
It’s an important question, which needs an answer. The problem is, it’s not a straightforward answer and our initial response is always “it depends”.
When asked this question, we also make the point that the interest rate, whilst important, may not be the main consideration.
Let me explain.
Firstly, to give you an idea, headline interest rates look something like this:
- Commercial mortgages usually attract an interest rate that is typically between 2% -5% above the base rate.
- On development finance, the interest rate is usually somewhere between 6% – 12% per annum, although it can be more on occasions.
- When it comes to an unsecured business loan, we have done numerous deals where the interest rate has ranged between 5.9% and 14.9% per annum.
- With bridging loans, the spread of interest rates can be anywhere between 0.49% per month up to in some cases 1.5% per month or more.
Now you see the predicament when we try and answer the question: “what’s the interest rate”.
So, what affects the interest rate? What makes the rate higher or lower? There are numerous reasons which include some or all the following:
- Loan to value ratio where a freehold property is a security for the loan
- Property type
- Property location
- Ability to service the loan – for instance, the strength of the accounts
- Credit file of the borrower
- Lenders perception of risk
There are of course other factors that can affect the interest rate, but these are some of them.
However, as I mentioned earlier, the interest rate is not the only consideration.
The amount you pay each month is arguably more important than the interest rate you are being charged, particularly when it comes to, for instance, a business loan or commercial mortgage.
The monthly repayment is the amount you pay the lender each month to service the loan and of course, it is paid directly out of the cash flow of your business each month.
So, whilst having a good interest rate is important, I would argue that having a monthly repayment that you can afford is far more important.
Let me illustrate my point:
A repayment loan of £250,000 at base rate + 3.5% over 10 years = monthly repayments of £2,550.
A repayment loan of £250,000 at base rate + 4% over 20 years = monthly repayments of £1,615.
Now, which is the best deal?
Based solely on the interest rate, then the first option at base rate + 3.5% is the better deal. However, it’s no deal at all if your cash flow can’t afford £2,550 per month.
In which case, option two over a 20-year term becomes not only the better deal but the only option!
And the term of the loan is not the only consideration. Does capital repayment work for you or would interest only be better?
If you choose interest-only do you want the flexibility of being able to repay capital sums without penalty?
And what about early repayment charges? Some lenders don’t charge them at all; whilst others levy hefty charges for partial or full redemption, particularly in the first 5 years of the loan.
Are seasonal repayments important to you? We had a client who owned a Guest House in the West Country, for whom seasonal repayments were vital. Having given the client some funding options, they chose a lender who was slightly more expensive on the interest rate but who offered the flexibility of monthly repayments that were structured to meet the seasonal nature of the client’s business.
In summary, the interest rate being charged is a key consideration when choosing the right funding for your business needs. As a result, it is an important question to ask.
But it needs to be part of a much bigger discussion when you are looking for the right deal.
As a result, you also need to think about your cash flow requirements and what the monthly repayments will be.
- Would a fixed rate work best for you?
- Or do you prefer a variable rate?
- What term of loan do you want?
- Will you want the flexibility of being able to make repayments of capital without penalty?
- Do you want repayment or interest-only?
As you can see, there are many variables that go way beyond just asking: “what’s the interest rate”.
So, if you’d like to find out more by talking to an expert, then why not get in touch? Our contact details at Funding Track are 020 3857 3030 and firstname.lastname@example.org
Next week’s FAQ is a question every client asks: How much do you charge?