Updated: Jun 2, 2016
Coy about costs. Brushing over the fine print. Pressuring you into something bigger or more expensive than what you need…
If you’re an entrepreneur, chances are you’ve had at least one uncomfortable encounter with a lender who just didn’t seem to have your best interests at heart.
Earlier in my career, my partners and I built up a network of successful fitness businesses. The business grew quickly, and we started shopping for a small business loan to help us expand our profitable model to new markets. It was during this time that I got my first glimpse into the opaque underbelly of the traditional lending industry. We were shocked at how many lenders literally could not produce an amortization and repayment schedule. And when we asked them to share their fee structure and APRs? Crickets.
There are 28 million small businesses in the U.S. These entrepreneurs create two out of every three net new jobs and employ half of the private sector workforce (about 120 million people!). They deserve better. They deserve an efficient and transparent way to fulfill their growing capital needs, and they deserve to understand the true cost of their loans.
The good news is that there are some simple tricks you can use to weed out the bad apples and ensure you get a fair deal on your financing. If you’re looking for an injection of cash to jump-start your business, here five ways to avoid overpaying for a loan:
Application fees, annual costs, service charges, origination fees — you have the right to know the total cost of any loan you are offered so you can easily compare it to other offers and make the right decision for your business.
Unfortunately, financing has traditionally been sold with pricing that can be confusing or misleading — and the true cost of a loan is often not disclosed. Instead, some lenders quote “rates” that are calculated a little differently from a true interest rate, so their products appear cheaper.
One of the best ways to do an apples-to-apples comparison on loan products is to calculate the APR (annual percentage rate), a figure that tells you all the costs for one year in a single equivalent interest rate. It’s the true cost of your loan because, unlike an interest rate, an APR also takes into account additional fees and charges often hidden in the fine print, and also normalizes for how frequently you’ll need to make payments.
Many merchant cash advance lenders claim they can’t calculate an APR or that an APR is irrelevant because they’re not offering term loans. That’s fundamentally wrong. They may not like it, but they can definitely do it.
There are some products with high APRs that make sense for certain businesses in some circumstances, but a lender should be able to make that case transparently and equip a borrower with the right information to make the right decision for his or her business.
A good lender will always be willing to help you calculate an APR, so that you can accurately compare your options.
Read more: Learn how to calculate your own APR
Some lenders charge a fixed repayment amount, making it impossible for you to save money by paying early. This is not always transparently disclosed, so if in doubt, ask the lender to explain how much you’d owe if you repaid early on a specific date. If it’s greater than the principal outstanding, then there’s a prepayment penalty. End of story.
Read more: See what other fees you should look out for
If you take out a new loan before repaying an existing one with a lender, ensure you are not unfairly double charged for the outstanding portion of your loans. The new fixed charges should only be calculated based on the additional capital you have received.
For example, a business owner who still owes $10,000 on a loan may take out a second loan for $25,000. The $10,000 could be rolled into the new loan so he or she only receives $15,000 of new capital. However, if this individual is charged fees on the full $25,000 amount, he or she would have effectively been double charged on the outstanding $10,000 amount.
Read more: 4 reasons to refinance your business debt
Stacking occurs when you to add a loan or cash advance product on top of another credit product you already have from a different lender.
In this situation, you could end up with multiple cash advances “stacked” on top of each other, each diverting a percentage of sales from reaching the business. This can quickly become a boa constrictor around your business’s cash flow.
Whether you’re in a tight spot or want to jump on an unexpected business opportunity, it’s important to remember that just because you need another injection of capital, doesn’t necessarily mean you need a whole new credit product.
Instead, consider whether refinancing your existing debt could potentially lower your overall costs compared with the temporary boost you would get from taking out a new loan or cash advance.
There are two ways you can do this: One option is to take your current term and stretch it out a little longer to lower your monthly principal and interest payments. This is likely to increase your rate, but could be a completely reasonable strategy for the long run. The second, trickier option is to find a credit product with a lower interest rate and refinance — as long as the origination fee and any other charges on the new loan are less than the lifetime difference between the old and new interest rate payments.
Before you start shopping around for a loan, work with your accountant or financial advisor to figure out how much money you actually need to accomplish the goals you have for your business. Avoid lenders who attempt to upsell you on a much bigger loan than you need or who try to pressure you into accepting offers too quickly. Sometimes the lure of additional working capital can be tempting, but remember it’s about finding the right sized financing for you.
To learn more about your rights to fair and transparent financing, check out the Small Business Borrowers’ Bill of Rights.
Sam Hodges is co-founder and U.S. managing director of Funding Circle. He is responsible for overseeing the overall strategic direction and day-to-day operation of the company in the United States.