Understanding Interest Rates: A Guide for Small Business Owners

If you’re a small business owner in India, chances are you’ve either taken a business loan or are thinking about securing one. Loans are a common way for MSMEs (Micro, Small, and Medium Enterprises) to manage cash flow, grow their operations, or invest in new opportunities. However, there’s one aspect of a loan that can be confusing to many, i.e., interest rate.

For many Indian MSMEs, understanding how business loan interest rates work remains a challenge. Here, we’ll simplify the concept, helping business owners make smarter borrowing decisions.

Why do interest rates matter to small businesses?

The interest rate on your business loan is the amount the lender charges you on the borrowed fund. It directly impacts the cost of borrowing. A higher interest rate means paying more over time, which can affect the cash flow, profitability, and growth plans of the company.

 Here’s why interest rates are important for small businesses:

•  Loan affordability
  The interest rate on a business loan directly affects the monthly EMI.  A higher rate increases repayment amounts, making loans more expensive. Lower rates improve affordability and reduce the repayment burden.
• Cost of capital
  Higher interest rates increase the total cost of financing operations or expansion of the business. So, controlling the interest expense is crucial for maintaining profitability.
• Profit margins
  When interest rate rises, a larger portion of the business earnings goes toward repayments. This can reduce profit margins, especially for small or low-margin businesses. Lower interest helps preserve more revenue for growth or savings.
• Decision-making
  Knowing the interest rates of different lenders allows businesses to compare loan options effectively. It helps identify the most cost-efficient financing solutions. Smart comparisons can lead to significant savings over time.
• Financial planning
  Predictable interest rates support consistent and reliable budgeting. They help businesses forecast future expenses and plan long-term goals. Fixed rates, in particular, offer financial stability during the loan term.

In short, understanding interest rates helps small businesses make smarter borrowing decisions and maintain financial stability.

Types of business loan interest rates

In India, business loan interest rates come in two types: fixed and floating. Let’s check these in detail.

Fixed interest rate

It is a suitable option for borrowers who prefer predictability and stability in their loan repayments. With this type of rate, the interest remains unchanged throughout the loan tenure, ensuring that the EMI (equated monthly instalment) stays consistent. This makes it easier to plan and manage your finances, as there are no surprises due to market fluctuations. However, the drawback is that you won’t benefit if market interest rates decrease during the loan period.

Floating interest rate

It is ideal for small businesses that are comfortable with some variability and want the opportunity to benefit from declining market rates. This type of rate is linked to market conditions, particularly the Reserve Bank of India’s (RBI) repo rate, and can fluctuate over the loan period. As a result, the EMI may increase or decrease depending on how the market moves. While this flexibility can help you save money when interest rates drop, it also comes with a degree of risk, as payments may rise if rates go up.

Factors affecting business loan interest rates?

Lenders don’t offer the same interest rate to every business. Here are some elements that influence the interest percentage you’ll be charged:

Credit score

Lenders look at both your personal and business credit scores. A CIBIL score above 750 is usually considered good and can help you get a lower interest rate.

Business age and revenue

Older businesses with stable incomes are seen as less risky by lenders. If your business has been profitable for a few years, you’re more likely to get better rates.

Type of loan

Loans backed by security (like property) often come with lower interest rates. These are called secured loans. Unsecured loans, which don’t need collateral, usually have higher rates.

Lender type

Different lenders offer different rates. For example:

• Public sector banks may offer lower rates but take longer to process.
• Private banks may be faster but slightly more expensive.
• NBFCs and fintech lenders often have easier paperwork and fast processes but may charge a bit more.

RBI monetary policy

When the RBI changes the repo rate, loan interest rates across the country also change. If the repo rate goes down, new loans often become cheaper.

How to get a better interest rate?

Here are some simple tips to improve your chances of getting a lower business loan rate:

Improve your credit score

Always pay your bills and EMIs on time. Check your credit report regularly for any mistakes. A strong credit history builds trust with lenders.

Maintain clean financial records

Keep your business accounts, GST filings, and ITRs updated. Lenders often ask for 6-12 months of bank statements and profit and loss reports.

Compare offers

Don’t accept the first loan offer you get. Compare at least 2-3 lenders before making a decision.

Negotiate

Yes, you can negotiate! If you have multiple offers, you can ask your preferred lender to match or lower the rate.

Offer collateral (if possible)

If your business can offer collateral like property, machinery, or stock, you may be able to get a secured loan with a lower interest rate.

Common myths about business loan interest rates

Let’s clear up a few common misconceptions surrounding business loan interest rates:

Myth 1: A lower interest rate means the cheapest loan

Not always. Some lenders may charge high processing fees, prepayment charges, or other hidden costs. 

Myth 2: Only banks give low-interest loans

NBFCs and fintechs can offer competitive rates, especially for businesses with strong digital footprints.

Myth 3: Personal credit score doesn’t matter

For most small businesses, especially sole proprietorships, the owner’s personal credit history is very important.

Myth 4: EMIs stay the same for every loan

EMIs can change in floating rate loans or if there are special terms in your loan agreement.

Real-life example: Ramesh’s stationery business

Let’s imagine that Ramesh runs a stationery wholesale business in Pune. He wants a ₹5 lakh loan to buy stock before the new school season. He compares offers from a public bank (11% fixed rate), a private bank (13% floating rate), and a fintech lender (14.5% fixed rate).

Since Ramesh has a good credit score, updated GST filings, and a three-year-old business with steady profits, he qualifies for all three loans. After reviewing the total cost of each loan, including processing fees and flexibility, he chooses the private bank’s floating rate loan. By understanding the interest rate and making a smart choice, Ramesh saved nearly ₹12,000 over the loan tenure.

Closing thoughts

Understanding interest rates on business loans is the first step to making better borrowing decisions. However, only knowing about it is not enough, you need a trusted lending partner who supports your business goals with the right financing solutions.

TallyCapital provides seamless and reliable financial solutions to Indian MSMEs by partnering with trusted lenders, simplifying access to capital, and empowering businesses to overcome challenges and grow with confidence. Whether you need a business loan or financial guidance, we’re here to support you at every step of your journey.