Unmasking APR: How to really compare business loan rates
Knowing the true cost of a loan can be complicated, especially with different lenders advertising different rates, under different terms. However, while this is a good starting point, there are a lot more factors to consider when calculating the true cost of your loan.
Annualised Percentage Rate (APR)
APR measures the cost of a loan over a one-year comparable term and is probably the best tool to use to get a thorough loan comparison. Let’s be clear, APR is not necessarily the same as Interest Rate. Interest Rate is a loose term that can be applied annually, monthly, weekly or even daily, and may or may not constitute the APR. If anything, APR is a much more accurate and standardised representation of how much a loan is going to cost per year.
Effective APR is an annualised rate that takes into account any loan fees, recurring charges and compounding interest. Essentially it calculates everything about the loan rather than just the nominal interest rate.
APRs allow you to easily calculate cost and compare business loans with different fee structures.
To break it down: if you borrow $10,000 to be repaid after a year at 10% interest, then the APR is 10% – you pay $11,000 after one year, simple right? But what if you borrow that $10,000 at 10% but to be repaid after 6 months? You still have to repay $11,000 but the APR is actually 20%. This is the same for 3 months (APR is 40%) and 1 month (APR is 120%).
In all of these scenarios, some lenders will still advertise a 10% “Interest Rate” – which is technically true – however the APR’s are very different, as is the actual cost of the loan.
Amortisation also affects APR and needs to be factored into the calculations. For example: our $10,000 loan above, with principal and $1,000 interest paid at the end of one year has a 10% APR. However, if that $10,000 loan has monthly repayments then the APR is actually 20%, even though the “Interest Rate” may be 10% and the loan term is technically 12 months. This is because the borrower has only had the benefit of the loan for, on average, only half the year. The faster the loan is repaid, the higher the APR (if the total interest paid is fixed) – the same is true of fees baked into a loan.
What to Look For
Unfortunately, calculating APR is rarely that simple; you have to factor in establishment costs, recurring fees, early and late repayment fees etc. Add that to the fact that Small Business Lenders don’t and aren’t required to advertise their APR, and you’ve got a very confusing loan interest calculation.
One of the biggest things to look out for is early repayment fees. Many lenders will advertise that they have no early repayment fees, but be skeptical! While they may not have any explicit early repayment fees, they may still require you to pay some or all of the outstanding interest on the loan. In these cases, it’s basically still an early repayment fee and your APR has just skyrocketed!
At the end of the day, the questions you need to ask yourself are:
- What is this loan costing me? (Any hidden fees or charges?)
- Are there any unclear terms? (Is the rate being marketed as APR or a percent of the notional?)
- Does funding at that cost make sense?
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Article content courtesy of Moula Money.