How do I know I'm getting a good rate? Secrets your Banker doesn't want you to know.

The most obvious way to know if your getting a good deal on your interest rate is to obtain at least three offers from Banks. The second way is not so obvious and is something that your Banker probably would prefer you not know. Here is the quick test.

1) Find out what index or source of funds your loan is based on. Most proposal letters will (should) tell your that your ten-year loan is based on the Ten-Year Treasury, the Ten-Year Federal Home Loan Bank, the Bank's own Cost of Funds, or LIBOR. You can check these base rates on the Internet or in newspapers such as the Wall Street Journal.

2) Take the stated interest rate found in your proposal letter and subtract the base rate determined in Step 1 above. For example, your proposal letter might state a 12% interest rate based on the Ten Year Treasury, which is at 9% (for example only). So 12% minus 9% equals 3% and that represents the Bank's revenue on the loan - revenue not profit. The spread between your stated rate and the base rate tells you a couple of things. First, the greater the spread the greater perceived risk by the Bank on your loan. Second, if you have an existing relationship with a bank, the spread can tell you if they are taking advantage of your company's business.

A fair spread between the index and the stated rate in the proposal letter is usually 2.00% -2.25%. This would represent a normal risk profile and most likely equates to a decent profit for the Bank. Remember, your Bank needs to make money as well and a bank that's not making money on your account will not be that helpful if things go bad.

Spreads in-excess of 2.25% could represent increased risk in the transaction or aggressive profit taking by your Bank. Risky transactions might include acquisition financing, shareholder buy-out that will affect the balance sheet, or a loan to fund net losses in the business. If any of those factors are involved then the Bank is just trying to risk adjust the rate they are charging for the new risk involved.

If your loan request is a normal term loan to buy a new machine, a line of credit to fund growth and your leverage isn't that high (below 3.5x), and your making money, then a spread above 2.5% means that your Bank is trying increase the profit on your relationship. I would speak to your lender and remind him or her of your relationship and that the pricing of the loan doesn't reflect that relationship. The banker might be so embarrassed that he or she might lower the spread to 2.00% or better.

So remember, an interest rate spread above 2.50% requires you to ask questions and either gain an understanding and respect for how your bank is looking at your loan, or come to the realization that your bank is gauging your cash flow through higher than necessary interest rates.