Small business explainer: How do interest rates work?

Over recent years, interest rates have fluctuated significantly, creating uncertainty for the UK’s small businesses.

As a small business owner it’s vital to understand interest rates so you know how changes in the base rate might affect your business, as well as how much you are committing to paying back when you take out a loan.

Here we explain what might affect the interest rate on your business loan. 

Base rates and the Bank of England

The Bank of England sets the base rate for borrowing and saving. In the past five years, the base rate has gone from a historic low of 0.1% in March 2020, as a result of the COVID-19 pandemic, to a recent high of 5.25%, which lasted for a year between August 2023 and August 2024.

The base rate has been slowly falling since August 2024, with the latest cut coming on 8th May 2025. The Bank of England base rate is currently 4.25%. 

It’s expected that the base rate will continue to be cut further this year. Although by how much is unsure at this point, following the unexpected rise in inflation in May.

Banks and other lenders will usually adjust their interest rates in line with changes to the base rate. If you have a variable rate loan and the base rate goes up, your interest rate will likely go up as well. Fixed rate loans, however, are not affected.

What is an interest rate?

When taking a loan, the lender will charge you interest on the loan amount. The interest rate simply states how much interest they will charge. 

The lender may also charge fees, such as an arrangement fee or annual servicing fee. Together with your interest, these make up the cost of taking a loan.

What affects your interest rate?

A key factor in determining your interest rate is the amount of time you want to borrow for. You can reduce your monthly repayments by choosing to repay over a longer period, which could make borrowing a large amount more affordable. However, usually the longer you borrow for, the higher your interest rate will be.

Finding the balance between affordable repayments and adding to the cost of finance is important to making the right choice for your business.

The other key factor is how creditworthy your business is. When you apply for a loan, the lender will perform a credit assessment. The better equipped they believe you are to repay the loan, the lower your interest rate could be.

The combination of your credit rating and loan term defines the interest rate you’ll pay.

Different interest rates – what they mean

APR – Annual Percentage Rate

APR includes both the interest rate on your loan and any fees the lender charges, such as annual servicing fees. The idea is that it provides a quick indication of the total cost of your borrowing, rather than having to get a breakdown.

However, you should be aware that with APR, you may not get the advertised rate. When a lender states a loan’s representative APR, it means that 51% of customers they approve will get that rate. The other 49% could get something different.

AER – Annual Equivalent Rate

When borrowing, AER shows the rate after interest is paid and compounded for each year. Unlike APR it doesn’t incorporate fees, so you need to include them in your calculations if you’re quoted a rate in AER.

Flat rate

Whereas APR and AER are calculated on the amount outstanding, with a flat rate the interest is charged on the original amount borrowed. So if you borrow £10,000 over five years, even on your last repayment you could be paying interest on the full £10,000.

Typically flat rate loans offer a lower rate to make it more appealing, but the total cost is far higher.

Fixed rate vs variable rate

Fixed rate loans mean your interest rate won’t change over the lifetime of your loan. Variable rate means it could go up or down in the future. It’s important to note the type of loan you’re getting so you can plan for the future.

What are the interest rates at Funding Circle?

All loans at Funding Circle are fixed rate. By knowing exactly what your repayments will be each month, you can make plans for your business more effectively. You can find our current interest rates here.

There are no early repayment fees when you pay in full, so if you would like to pay off your loan in one go, you’ll only pay interest on the time you borrow.

If you think a business loan might be right for your business, apply online in just seven minutes and get a free, personalised quote.

26/05/25: While we want to help as much as we can, the information found here is provided solely for informational purposes and should not be considered financial or legal advice. To the extent permitted by law, Funding Circle does not accept any liability for any loss or damage which may arise directly or indirectly from the use of, or reliance on, the information contained here. If you have any questions, please speak to your professional adviser or seek independent legal advice.