Updated: Nov 16, 2015
As you begin the process of shopping for a small business loan, it’s easy to become overwhelmed by fast-talking salesmen, endless strings of acronyms and deals that seem too good to be true.
How do you cut through the chaos and make sense of it all? The key is to calculate the Annual Percentage Rate, or APR, of a business loan before you sign the dotted line.
At Funding Circle, we believe that transparency builds trust, so we’ve put together a quick tutorial on one of the most familiar and least understood terms in finance: APR.
APR, or annual percentage rate, is a figure that tells you the true cost per year of borrowing money. It’s the true cost of a small business loan because unlike the interest rate, APR also takes into account additional fees and charges that are too often hidden in the fine print.
As a result, the APR is generally higher than the advertised interest rate, so it’s important to ask about the APR when comparing competing loan offers, or even better: learn how to calculate it yourself.
The Truth in Lending Act requires most credit lenders to disclose the APR and terms of the loan prior to signing, but it’s also possible to calculate the APR on your own if your lender is transparent about details of the loan.
(Side note: If your lender isn’t upfront about the way their APR is calculated, it’s probably a good indication of a bad deal.)
To calculate your APR, you’ll need:
1. The amount of the loan
2. The interest rate (ask whether it compounds daily, monthly or annually)
3. A list of all additional fees*
Math wizards can try to work it all out by hand, but if you don’t want to worry about “carrying the two,” you can save yourself from unnecessary flashbacks to high school math exams by using a specialized APR calculator.
*The only additional fee that Funding Circle charges at the time of signing is a 3.49%-6.99% origination fee. If you borrow from another lender, possible additional costs include fees for underwriting, loan processing, document presentation, loan application, early repayment penalties, etc.
It’s tempting to simply look at the interest rate when comparing potential loan offers, but it doesn’t give you the full picture.
For example, one loan may have an attractively low interest rate, but if it is compounded daily or associated with a whole bunch of additional fees it may wind up being much more expensive than you originally thought.
Given the amount and term of your loan, APR takes into account all of the costs associated with a business loan and is the best metric to help you compare “apples-to-apples.”
Lowering the APR of a business loan is pretty intuitive. A low APR generally indicates lower interest rates and fewer associated fees. But you can also lower your APR by extending the term of your loan. Keep in mind, however, that longer loans are often associated with higher interest rates.
While APR is a critical number to consider when comparing competing loan offers, it’s also important to look at the APR in the context of the full terms of the loan.
For example, APR alone isn’t a direct indication of how much interest you’ll wind up paying over the life of a loan.
In the scenario below, increasing the length of the loan allows you to pay less per month — and therefore per year — thus lowering your APR. But because there are more payments, you’ll wind up paying an additional $48 in interest.
Selecting a business loan with a lower APR may also not be optimal if you are quoted a variable APR.
With a variable rate, the lender reserves the right to change the interest rate during the life of the loan depending on conditions totally under their control. A variable loan that started with a low APR could wind up costing you much more after the promotional period expires.
You might prefer to take the business loan option with a lower APR because the additional cost is spread over the course of three years. But if your priority is to save money, you should pick the loan with the higher APR in this scenario. Whichever one you choose, you need to calculate the APR and understand the details of the loan in order to make an informed decision.
On the other hand, Funding Circle always offers a fixed annual interest rate throughout the life of your loan, so there are no unexpected surprises down the road.
Before you sign any papers, you should understand all of the terms and conditions associated with your business loan. Calculating your APR is an essential step in evaluating a loan offer, but it’s not the only metric you should consider.
Honesty and transparency are part of Funding Circle’s core values, so we provide small business owners all of the information required to calculate the true cost of a loan.
We offer fixed interest rates as low as 4.99% and only ask for a one-time origination fee of 3.49% to 6.99%. It’s free to apply, with no monthly servicing fees, early repayment penalties or other hidden costs.
You’ll also be assigned a personal account manager to answer any questions you have about your loan before you sign. You can easily request an amortization schedule, so you know exactly how much is due each month. Your account manager can even help you calculate your APR, which — of course — you now know how to confidently calculate on your own!
You deserve to work with a lender who empowers you with the knowledge you need to make the best possible financing decisions for your business. Check your eligibility today for a small business loan with Funding Circle.