Time Value of Money
Before we start talking about interest rates, let’s talk about the Time Value of Money. Understanding this should make it easier to understand how interest exists in the first place.
Time Value of Money is the idea that a set amount of money—let’s say P100,000—is worth more today than it will be worth in the future. This is because of the potential earnings you can get from money that’s available today, which you can’t get if the money will only be available in the future.
For example, if you had P100,000 today, you could invest it into your business and turn it into P200,000 after a year. If you could only get P100,000 a year from today, then you would just have P100,000 without any other potential earnings.
Having money now is more valuable than having the same amount of money in the future, and that is why lenders can charge interest when giving out loans.
A Practical Definition of Interest
Interest is like a rental fee that a borrower pays to get money right away. Just like renting a house or an apartment, you get to use the money immediately but you have to give it back at some point in the future. You also have to pay “rent” in the form of interest for being allowed to borrow the money at all.
An interest rate is basically the “rental fee” described as a percentage of the loan amount. For example, if you are paying P10,000 in exchange for borrowing P100,000, then your interest rate is 10% or P10,000 divided by P100,000.
Most lenders will quote their price as an interest rate rather than a peso-amount because everyone borrows different amounts of money. It’s much less confusing to quote the price as a consistent interest rate rather than quoting different peso-amounts for each borrower.
What is a “Good” Interest Rate?
Now that you understand what interest is and why it exists, you’re probably wondering, “What’s a good interest rate?” The short answer is, it depends on a few things:
- Are you borrowing or lending? If you’re lending your money to someone else, like when you deposit money into a bank account, higher interest rates are generally better. If you’re borrowing money from someone else, like if you decide to take a car loan, lower interest rates are generally better.
- What are your options? Regardless of whether you’re lending or borrowing money, a “good” interest rate will always be relative to your other options. Earning 2% interest on your savings account sounds great if your other options will only give you 1%, but the picture suddenly changes if you find out you could earn 4%. The same principle applies to comparing loan interest rates. Don’t be afraid to shop around and look at a few proposals before choosing one.
- Are there any other costs to consider? We’re not talking about interest rates anymore here, but it’s important to know that interest is often just one of many costs to borrowing money. Banks don’t just pay interest to depositors in order to borrow money. They also have to pay for employee salaries, ATM machine maintenance, utilities for their branches, and more. Similarly, you may have to pay processing fees or provide collateral if you’re taking a loan. Getting 0% interest doesn’t seem like such a good deal if you have to pay 20% in processing fees or provide P10 Million worth of collateral.
Take some time to answer these questions and you’ll naturally start to get a feel for what seems like a good interest rate for you and your situation.
If you don’t like any of the options available, then you might also want to ask yourself if you can wait until a better deal comes along. Remember, time has value. If you’re not willing to pay interest to get money now, then maybe it makes more sense for you to wait until you earn the money yourself or until a better loan offer comes along. Knowing how to compare the cost and benefit of a loan is a whole other issue, but we’ll cover that in our next article.
Interest Rates for Business Loans
When it comes to understanding interest rates for business loans, there are 3 main things that will affect how low or high your interest rate will be.
- The Financing Partner - Different types of lenders have different business models. Some offer lower interest rates but are very selective with who they lend to. Others make it easy to borrow, but charge high prices because they expect more customers to default on their SME loans. This has a big effect on the interest rate they will offer you, simply because of what they can offer you in the first place.
- The Loan Product - Lending companies can also have very different interest rates depending on the exact loan product you’re looking at. Different loan products are built for different uses, so it’s natural for them to have different limits, features, and pricing. You might even find that the same interest rate will result in different costs, depending on how it is applied. Make sure to read the contracts carefully, because they will have the most complete information on everything you need to know about the specific loan product being offered to you.
- Your Risk Profile - Lenders all have their own way of deciding how risky each customer might be, but they will always offer higher interest rates to businesses that they think have a higher risk of not paying back the loan. If you’re operating in a high-risk industry like construction or had late payments on loans in the past, lenders will likely offer you higher interest rates. On the other hand, a good relationship with your financing partner or a history of paying on time may help you get lower interest rates compared to what is available to the public.
Low Interest Rates for Growing SMEs
It has always been First Circle’s mission to give more SMEs access to affordable financing. The interest rates for our Revolving Credit Line are some of the lowest you’ll find for non-collateral loans in the Philippines today, and we’re always working to make them even more affordable.
Our best customers currently enjoy interest rates as low as 1.39% per month, and they can even get extra discounts by referring other businesses or simply being loyal customers of First Circle.
If you’re interested in getting your own Revolving Credit Line or learning more about what First Circle can offer, send us an email at firstname.lastname@example.org. For more articles like this, check out https://www.firstcircle.ph/blog.