Business Loan APR: How to Easily Calculate Your Loan Cost
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When searching for a business loan, it’s important to understand how they work and how much they cost. No business loan is ever free. In exchange for money, banks charge a fee for the administration of the loan and the money borrowed over time.
Understanding the cost of your business loan will help you better plan for monthly payments and keep your organization’s finances in check.
What Does APR Mean?
The annual percentage rate, or APR, is the yearly rate charged for a loan. The APR includes all borrowing costs, such as origination fees, interest, and any other upfront costs.
The upfront fees your company is charged for a loan vary based on the type of loan obtained. There are several types of loans available to business owners, and each loan has its own borrowing conditions and fees.
What Is the Difference Between APR and Interest Rate?
You may be confused when reviewing loan documentation referring to an APR and an interest rate. Many borrowers assume that the business loan APR is the interest rate, but that isn’t the case.
A small business loan APR includes the annual interest for the loan plus origination costs and applicable transaction fees. When you’re considering a business loan, pay attention to both rates. A 0% interest rate may seem desirable, but high upfront costs can make the loan more expensive and eliminate any benefits from low interest rates.
What Are the Types of Business Loan APRs?
There are two types of APR: fixed and variable.
A fixed APR has a fixed interest rate and transaction costs that remain the same throughout the life of a loan. The most common types of loans with fixed APRs are term loans or loans that must be repaid over a specified period. For example, mortgages and automobile loans often have fixed APRs.
FURTHER READING: A Business Owner's Guide to Business Loans
A variable APR usually includes fixed fees related to the loan’s origination but a varying interest rate. The interest rate is typically tied to an index, such as the prime rate. If the index changes, the interest rate changes as well. Revolving credit, such as credit cards or lines of credit, often have variable APRs.
How to Calculate the Cost of Your Loan
How to calculate APR on a loan? Anytime you borrow money for yourself or your business, you should fully understand the costs. Understanding the cost of your loan makes comparing offers between lenders easy. In addition, you’ll be able to better prepare for the monthly payments you’ll make to your lender.
To calculate the cost of your loan, follow these steps:
- Add together the interest rate and all additional fees, such as origination costs, processing fees, referral expenses, and any other upfront fees.
- Divide the total amount of interest and fees by the principal of the loan
- Using the amount obtained from the first two calculations, divide by the total number of days in the loan term
- Multiply the total by 365 (days in a year)
- Multiply by 100 to convert to a percentage
The full formula is:
APR = ((Interest + Fees / Loan Amount) / Number of days in loan term)) x 365 x 100
Let’s consider an example:
You’ve been offered a loan for a company automobile with $2,000 in upfront fees and a 5% interest rate. The principal cost of the automobile is $20,000, with a term of five years. To calculate your annual APR, we’ll use the above formula:
Interest rate = 5% x $20,000 = $1,000 per year, or $5,000 total
5-year term = 365 days x 5 years = 1,825 days
APR = (( $5,000 + $2,000 / $20,000) / 1,825 days )) x 365 x 100 = 7% APR
Consider another lender, who is charging 6% interest with $300 in upfront costs on the same $20,000 vehicle with a 5-year term.
Interest rate = 6% x $20,000 = $1,200 per year, or $6,000 total
5-year term = 365 days x 5 years = 1,825 days
APR = (( $6,000 + $300 / $20,000) / 1,825 days )) x 365 x 100 = 6.3% APR
Even though the first lender is offering a lower interest rate, their upfront fees result in more costs to the borrower. The second lender, with a 6% interest rate and lower fees, is the more attractive loan for the customer.
How to Convert APR to Monthly Payments
Converting a yearly APR to monthly payments can provide a better gauge for businesses who need a firm understanding of how much they will pay toward their loan each month. Clear monthly payments can allow business owners to factor the loan into their cash flow, helping owners to better establish a budget they can rely on.
To convert the loans provided in the prior two examples to monthly interest payments, simply divide the APR by the number of payments in the year.
The first example contained a 7% APR. Thus, the interest paid for the first month would be 7% / 12, or .005833. When multiplied by the full principal balance of $20,000, the interest owed for the month is $116.67.
The monthly payment toward the principal is $20,000 / 60 months, or $333.33. Thus, the total monthly payment for the auto with the first lender is $116.67 + $333.33, or $450.
Under the second example, the APR was 6.2%. To calculate the monthly interest rate, divide the APR by 12 months:
6.2% / 12 = .005167
When multiplied by the principal balance of $20,000, the interest owed for the first month is $103.33. The monthly payment toward the principal remains the same: $20,000 / 60 months, or $333.33. In total, the borrower will pay $436.67 on their first monthly payment to the second lender.
Keep in mind that these examples are calculated using simple interest methods. In reality, most lenders have much more complicated ways of calculating the interest on their loans. Many use compounding interest, where the interest on a loan is recalculated based on the principal plus interest already assessed.
If a lender uses compound interest on their loans, you will need the assistance of a financial calculator or amortization table to better determine the cost of your loan.
Lenders may choose to compound interest daily, monthly, semi-annually, or annually. Compounded interest can significantly increase the cost of lending, so business owners should carefully consider the financial impact of a compounding loan.
Average APR for Small Business Loans
Business loan APRs can vary greatly across different lenders. Below is a chart highlighting the various types of business funding that Fundid offers as well as our average APRs:
What is a good APR for a business loan? This will vary depending on the type of loan you are seeking. You’ll want to compare offers from various lenders when making a decision on your loan.
At Fundid, we offer a variety of loan opportunities for companies that need assistance financing various aspects of their business. You can use our loans to purchase equipment, buffer your cash flow, acquire a new office, or meet just about any other business need.
The amount that you are able to borrow is determined by your credit score and time in business. You must have more than six months in business and a credit score of at least 550 to qualify for a loan with Fundid.
Understanding the total cost of a business loan is important to the overall financial health of your business. When shopping for business loans, you can use this information to compare the total cost of your loan offers.
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