Loans are the most popular form of raising money. They usually come in two distinct forms: secured or unsecured. They can also be on a fixed or variable rate of interest. The cost of a business loan is driven by the market and depends on a wide range of factors.

There are two types of business loan:

1. Secured loan: allows you to borrow against your assets, which might include your property or a personal guarantee from company directors or other types of asset. If you can’t repay the loan on the terms agreed with the lender, the lender can take assets to the value of the outstanding debt.

2. Unsecured loan: isn’t based on your assets, so the lender can’t claim any of your assets in the place of any unpaid debts that you are liable for.

How banks calculate the price of a loan

The price of a business loan is determined by both the market and a bank’s individual policy. It is one of the most competitive areas in banking, because you are free to choose which bank or lender to use. There are four key elements in the way a bank prices a loan:

1. Cost of funds

In order to lend money to businesses, banks need money to lend. They get this by attracting funds from depositors and paying them interest. The length of the facility will also have a bearing on the cost.

2. Cost of capital

For every loan a bank makes, it must set money aside. This ensures the bank remains solvent and depositors are secure, even if the loan is not repaid. There is a cost to holding this capital and as banks have increased the amount set aside, this cost has risen along with it.

3. Cost of risk

Price also reflects the probability – in the banks’ experience and according to its data – of the borrower not being able to repay the debt. The higher the level of risk, the higher the price must be to cover the likely loss.

4. Cost of administration

This reflects the cost of meeting a customer, assessing their application, setting up the loan, providing the documentation, maintaining the loan facility etc.