Your business started small- but now it's time to grow. While sales are great, you need a little extra help to expand your space, hire more staff, or buy new equipment. This is when entrepreneurs start looking to the benefits of a small business loan. However when it comes to financing a small business, there is no standard way loans are presented and plenty of online lenders use flashy marketing campaigns and bury the true cost of funding in the small print. As a borrower, it’s easy to become confused and overwhelmed by the various options. How do you cut through the fluff and find out which loan will be best for you?
In order to help you compare your offers and make the most informed decisions, we thought it would be best to explain some of the common rates and what they mean. Click here to download a quick guide to understanding loan rates.
Interest
Interest can be described as the proportion of a loan that the lender charges the borrower as compensation for the loss of the asset’s use; essentially, what the lender charges on top of the principal of your loan. This amount is expressed as a percentage rate (e.g., 12% interest on a $10,000 loan).
An important aspect to note here is that interest does NOT include any extra costs to your loan, such as origination fees, application fees, etc. In addition, the amount of interest the lender charges varies based on how risky they believe your company to be. The lower risk they deem your business, the lower the interest rate; the higher the risk, the higher the interest rate.
Annual Percentage Rate
The Annual Percentage Rate (APR) is how the annual accumulation of the interest rate and other fees attached to the loan is expressed. It is the total rate you’ll pay on your loan. While the interest rate can be considered the bare-bones amount you owe, the APR takes every fee associated with the loan and expresses it as a complete annual calculation. And as the name suggests, it is written as a percentage.
While it might not always be in your best interest to pick a loan solely based on the lowest APR, it is helpful to note you can absolutely ask lenders to disclose this information to you in your research. Bottom line, the benefit of the APR is the baseline evaluation it provides.
Click here to find out how to compare your business loan options. Additionally, use an online calculator, to help you determine your total APR cost when shopping for loans.
Factor Rate
The factor rate (or money factor) is another way of expressing the interest charged on a loan with monthly payments. It's calculated as the total cost of borrowing divided by the loan amount. It is expressed as a decimal, usually ranging from 1.1 to 1.5 depending on a variety of causes -- such as how profitable you are, how long you have been in business, and your average monthly sales, to name a few.
A key element to help you understand factor rates is that time is not accounted for when it comes to the total cost you will owe. Unlike interest rates, which are calculated numerous times based on the number of payments you make as your loan decreases, factor rates are calculated one time based on the original principal of your loan.
In order to figure out the total amount you will owe on your loan, you need to multiply the amount you are borrowing by the number the lender presents to you. For example, if you are requesting a $10,000 loan at factor rate of 1.5 for 12 months, the total amount you will owe is $15,000.
Conversely, to try to determine the factor rate of your loan, you can divide the total financing costs by the loan amount. So, again, if you are asking for $10,000 and the lender says the total is $11,600, you can determine the factor rate is 1.16.
The tricky part about factor rates is that they can make loans look less expensive than interest rates; however, as you are asked to pay the equivalent of an “interest rate” up front, these type of loans can ultimately be more expensive and there is no available benefit for paying the loan off early.
See also: Veteran Small Business Owner Gets Decked by OnDeck: Prepayment Fees
Other Loan Fees
There are a few other fees that can show up at the culmination of the loan process:
Origination Fee
This is an up-front cost that the lender charges to cover what it takes for them to process the loan. This will vary from lender to lender based on their particular administrative needs.
Application Fee
This is an additional cost you may find that relates to processing your loan application. It usually includes any credit checks necessary to determine if you are approved for the loan, among other things.
Guarantee Fee
This only applies to you if you are applying for a Small Business Administration (SBA) loan. Since the SBA does not actually offer loans, but instead guarantees them to other lenders, there can be a cost associated with that relationship to the lender. Therefore, some lenders may place that fee on the borrower as part of the loan cost.
Analyze the Most Successful Course of Action
Just as soldiers in the military collect all information before analyzing the most successful course of action on a mission, the same must be done when determining the most cost-effective loan for your veteran-owned small business.
Ask the lender to show you all the costs associated with the loan -- including interest, origination fees, servicing fees, the full APR, as well as any early prepayment penalties and other costs.
Know the full contract when you sign. The financing of your loan has some of the most crucial long-term effects on your business, so being informed and choosing lenders wisely can be one of the most important decisions you make.
Here at StreetShares, we want you to get a fair deal. We disclose every rate, fee and even review the whole cost of the loan to each customer. Click here to apply for a small business loan or line of credit now.
We care about veterans, and it is our goal to provide the resources it takes to make your small business successful. We’ve created an eBook to help veteran-owned small businesses every step of the way, from startup to growth stages. The “Ultimate Guide for Veteran-owned Small Businesses,” includes resources to help you get started with your business as well as an entire section on what to know about financing. Download it now, here.
This communication is provided for informational purposes only. It is not intended to be an advertisement, a solicitation, or constitute professional advice, including legal, financial, or tax advice, nor is StreetShares providing advice on any particular situation. This is not an offer of credit. All applications are subject to approval, no guarantee of funding.
