The Beginner's Guide to Small Business Loan Rates and Fees
By Jared Hecht
When shopping around for small business loans, most people ask themselves a few important questions. How much money can you get? What’s the interest rate? How long will you have to repay what you’ve borrowed?
But there’s another question that everyone should ask before accepting a final offer:
“What are all the rates and fees associated with this loan?”
A business loan might look like a great deal—until you factor in the fees, costs, and penalties you didn’t know to look out for. Here’s a breakdown of the 10 most important rates and fees when it comes to small business loans.
3 Types of Rates for Business Loans
1. Interest Rate
You probably have a pretty firm grasp on interest rates already:
An interest rate is what you pay on top of what you borrow from a lender (also called the principal). Lenders charge interest so they can make a profit off letting people borrow their money. And generally speaking, the “riskier” your lender believes you are, the higher your interest rate will be.
You can calculate your interest rate in two ways: as simple interest or as compound interest.
Simple interest is a straightforward calculation that takes into account the amount you’re borrowing, the yearly interest rate, and the amount of time you’ll be paying the loan back. Here’s the formula:
Simple interest = Principal x Annual Interest Rate x Duration of Loan (Years)
Compound interest, on the other hand, is a bit more complicated—it compounds, or recalculates, your repayment based on monthly payments. When you repay a loan, you may wind up paying interest on interest in the end, and compound interest takes that into account.
Whichever formula you use to calculate your interest rate, the idea is the same. Your interest rate is the basic percentage of what you’ve borrowed that you’re paying back to the lender.
2. Annual Percentage Rate (APR)
Interest rate is the barebones cost of borrowing, but APR is the all-inclusive calculation.
APR, or annual percentage rate, combines your interest rate with all sorts of different fees and costs associated with your business loan, many of which we’re about to go over. They’re all rolled up into one number that indicates the total cost of your loan.
As of 1968, the Truth in Lending Act mandated that lenders release the APRs of their loans in addition to their interest rates, so that consumers and business owners like you could compare your options apples to apples. That’s the real power of APR—letting you understand, between two loans, which one will cost more in total.
While knowing a loan’s APR is incredibly helpful, you shouldn’t forget about its interest rate. APRs take interest rates into account, but it can still be useful to split a loan’s costs into recurring expenses and one-time upfront fees. Use both numbers to make an informed decision about your business financials.
3. Factor Rate
A factor rate is like an interest rate—but it’s usually used for cash advances and some short-term loans.
While an interest rate takes the form of a percentage, a factor rate (also called a buy rate) looks like a decimal instead. You might see factor rates of 1.2 or 1.4, for example. And factor rates seem easier to deal with: you simply multiply the loan amount by the factor rate to determine what you’re paying back.
If you’re borrowing $10,000 for a year at a factor rate of 1.35, for example, you just multiply through to see that you’ll repay a total of $13,500. While the interest cost is 35%, all of the interest is charged to the principal when the loan or advance is originated.
Factor rates tend to be attached to more expensive loans. While you’re repaying an additional $3,500 in the above example, the actual APR could be more like 63%. (Calculate it here.)
7 Fees & Costs for Business Loans
Those are the rates to look out for—and here are a few common fees and expenses that business loans often come with.
4. Origination Fee
Origination fees, usually expressed as a percentage of the principal you’re borrowing, are charged by lenders in order to cover their basic upfront administrative costs.
The process of getting you to apply for and accept a loan takes time and money, after all. Phone calls, emails, interviews, data entry—these are some costs that lenders aim to recover with an origination fee. This fee will vary lender by lender.
5. Application Fee
These fees will also cover some of the costs lenders take on when processing your application, like checking your credit or appraising your business property.
6. Guarantee Fee
Guarantee fees only apply if you’re considering an SBA loan. The Small Business Administration doesn’t make loans—instead, it guarantees them for other lenders. As a result, your lender will likely have to pay a portion of that guaranteed amount to the government, and might very well pass that expense along to you.
7. Late Payment Fee
Many lenders will charge you an extra fee if you make a late payment, which is why you should stay as organized as possible when budgeting for your small business. If your loan payments are taken directly from your account, make sure you have enough money—and if not, then set reminders to pay your lender and avoid this fee.
8. Check Processing Fee
If you choose to pay your lender with checks rather than through debit or credit account transactions, don’t be surprised if you face a check processing fee as well. Processing checks often takes more time and manpower, which is why lenders don’t prefer this payment method.
9. Underwriting Fee
Similar to the application fee, the underwriting fee is how your lender recovers the time and money they spend underwriting your loan application. They evaluate your business’s financial statements and analyze historical trends and market data to figure out whether to offer you a loan, and what interest rate that loan should come with if you qualify.
10. Prepayment Penalty
You’ll face a fee if you pay too late—and if you pay too early, depending on your lender.
Not all loans come with prepayment penalties, and not all prepayment penalties are the same, but the general idea is that lenders will often lose out on money they expected if you repay your principal before the loan is due. In order to prevent that loss, some lenders charge prepayment penalties. In some cases, it could be a flat fee. In others, you may have to repay all or a percent of the remaining interest.
Whether you wait, or pay early and accept this penalty, is up to you and your business needs. However, you should make sure you’re aware of any prepayment penalties in your loan contract before you sign.
Although business loans come with more rates and fees attached, these 10 are the big ones you’ll need to know if you’re searching for financing. Good luck!
Jared Hecht is the CEO of Fundera, an online marketplace for small business loans. You can find him on Twitter at @jaredhecht.
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