MSMEs represent tomorrow’s growth engines for the economy and an important driver for MSME growth is loans. The expansion of small business is heavily dependent on MSME loans and the sme loan interest rates play an important part of growth of the small business sector. Navigating through the diverse interest rates available could be overwhelming for any business owner. The business success of such small businesses is not just linked to the loan amount, but also to the interest rates. Though MSME loans offered by banks have been the traditional source of funding for small businesses, there are several loan options by NBFCs as well.
While business owners typically avail of credit either for short-term obligations or long-term obligations and long-term capital expansion, deciding the appropriate loan could be a gamechanger for your business. Let us deep dive into several factors that affect MSME loans, interest rates and calculation, the way forward to identify the correct loan for your business, a comparison of several MSME loans available in the market, documentation, and some important dos and don’ts.
Factors affecting MSME loan interest rates
Different factors that are not necessarily independent of one another influence the interest rates on MSME loans. As a business owner, you need to be aware of the following factors –
- Creditworthiness
If the small business applying for an MSME loan has a high credit rating coupled with a high CIBIL score for the business owner, then the business is deemed to have high creditworthiness. In simple terms, it represents that the business does not usually default on credit payments. The loan lenders generally charge a lower interest rate for businesses having higher creditworthiness than the ones having lower creditworthiness.
- Amount of the loan
When the creditworthiness of the business is low and the loan amount is high, financial institutions provide a loan offer with a higher interest rate.
- Duration of the loan
Tenure of the loan also determines the interest rate. A loan with a longer tenure tends to have a higher interest rate than the one having a shorter tenure. This is because the lending institution faces a higher risk due to the extended repayment period in the form of inflation, market volatility, and opportunity cost. However, for the business owner, the EMIs for an MSME loan having a longer duration will be less than the EMIs for the one having a shorter duration.
- Collateral
If a business offers some kind of security against an MSME loan, also known as a collateral, then the interest rates are lower because the lender has in its disposal an asset that can be liquidated in case of a default.
Calculation of MSME loan interest rates
Generally, the interest rates hinges on two different calculation methods –
- Flat rate method
In this method of calculation, the interest is calculated on the principal amount of the loan for the entire duration. Irrespective of the fall in outstanding payable overtime, the interest payment amount does not get lowered which poses a disadvantage to small business owners availing MSME loans.
- Reducing balance method
Here, the interest is calculated on the outstanding amount of the loan, i.e., the amount which is left to be repaid. As the loan gets repaid progressively, the outstanding balance keeps on reducing that results in a lower amount of interest payment. Business owners may find reducing balance way of calculation to be advantageous.
The EMI of the interest can be easily calculated by using the formula –
EMI = P r (1 + r)n (1 + r)n – 1
Here, P = the principal amount of the loan
r = monthly interest rate
n = duration of the loan in months
You can also use this calculator to determine the monthly EMI, interest amount, and total amount payable.
Aspects to consider for choosing the right MSME loan
You need to consider the following aspects while deciding the appropriate MSME loan –
- Business requirements
You must be clear about the reason for needing a loan – meeting short-term or long-term obligations, starting up a new business, capital expenditure, business expansion, or investing in R&D. You also need to take into account the financing needs for your future. A good loan should closely align with your predictions of business growth and cash flow.
- Loan partners
There are different types of loan partners such as banks and NBFCs. A loan partner should be reliable and able to service your financing requirements end-to-end. A loan provider who can process your application digitally saves you from the inconvenience of physically travelling to their offices.
- Eligibility
When you have decided to apply for an MSME loan, ensure that you fulfil the loan eligibility requirements. For instance, your business must be registered as an MSME business. Also, you need to have a clean business history and high creditworthiness. Being ready with business incorporation documents, audited financial statements, and a plan for utilizing the loan gives your loan application the necessary weightage.
- Types of loans
You can either go for term loans or for short-term working capital loans. Term loans come in handy for long-term investments such as buying real estate and equipment, and R&D investments. Working capital loans can take care of your day-to-day business needs such as vendor payments, salary payments, etc.
Banks offering MSME loans in 2025
Different banks offer MSME loans with varying interest rates and other features as detailed in the following table –
| Sr. No. | Name of the bank | Loan details |
| 1 | State Bank of India | Interest rate is at the discretion of SBI with a processing fee of 1% on the loan amount. |
| 2 | HDFC Bank | Except the 1% processing fee, everything else is at the discretion of HDFC. |
| 3 | Indian Bank | Interest rate from 9.50% p.a. to 10.10% p.a. |
| 4 | Central Bank of India | Interest rate from 8.25% p.a. – 10.35% p.a. |
| 5 | UCO Bank | Interest rate from 8.85% p.a. onwards |
| 6 | Bank of Baroda | Interest rate at the discretion of the bank |
| 7 | Punjab National Bank | Interest rate at the discretion of the bank |
You can also avail of MSME loans from NBFCs as mentioned below
| Sr. No. | Name of the NBFC | Loan details |
| 1 | Mahindra Finance | Interest rate at 8% p.a. – 21% p.a. |
| 2 | Lendingkart | Interest rate at 1.25% per month |
| 3 | Muthoot Fincorp | Interest rate at the discretion of NBFC |
| 4 | SFMG India Credit | Interest rate at the discretion of NBFC |
Effect of MSME loans on small businesses
MSME loans affect a small business in several ways such as reducing profitability and cash flows along with growth. In an environment of high interest rate, the cost of borrowings increases for a small business that pulls down the available working capital. Especially, those higher interest payments require diverting money from other relevant operational or strategic activities. If the loan amount is large, then the financing costs can hit the profitability of the business. This prevents the business from realizing more shareholder returns or making long-term strategic decisions.
Overall, a higher loan repayment can prevent a business from growing due to lack of funds for new market entry, new product launch, R&D investments, working on cutting-edge projects, implementing new technology, and buying new equipment and land. As a business owner, you must be careful in considering the impact of MSME loan repayments on your business while prioritizing financial prudence of your business.
Tips to reduce interest rates on your MSME loan
- Provide collateral
One of the best ways to reduce the interest rate burden on your loan is to offer collateral in the form of an asset which reduces the lender’s risk. You can offer collateral as a percentage of the loan amount. Higher the percentage, higher the security, and therefore lower the interest rate. High collateral percentages are in the range of 80% – 90%.
- Maintain high credit score
Maintaining a high credit score tells the lenders that you do not default on borrowings. A good credit score also increases your reputation because it reflects that you can operate your business profitably covering all obligations.
- Negotiate
Never back down from negotiating terms with the lender if you believe your business plan is radically different and revolutionary. Before negotiating, make sure that you have a strong financial history so that the loan offer is sweetened for you. Banks and NBFCs have some discretionary power over interest rates and if they believe in the business pitch and potential backed by strong financials, then they know that they will get their money back.
- Look for government schemes
You can also avail of MSME loans from PMEGP and MUDRA schemes of the government. Government MSME loans usually have lower interest rates than private lending institutions.
Alongwith the above factors, it would be a good idea to avoid taking loans during a high-interest rate economic environment because borrowings become costlier. Wait till the central bank reduces the repo rate by a few basis points and then you can choose an MSME loan that suits your needs.
Conclusion
Availing an MSME loan has several implications for small business owners all of which involve a strain on financial resources. As a business owner, you need to navigate the complexities of your business with prudent financing decisions that address your short-term and long-term business needs. Choosing the right MSME loan could be the reason for your eventual business success or failure. So, choose your MSME loan wisely!