The Beginner’s Guide To APR For Small Business Loans

Wondering how to compare the cost of small business loans? This beginner's guide to APR will show you how to compare the cost of borrowing to score the best loan for your business.

WRITTEN & RESEARCHED BY
Kymberlin Bush
Expert Contributor

Last updated onUpdated August 20, 2024

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Key Takeaways

APR (Annual Percentage Rate) combines the interest rate and any associated fees, providing a comprehensive view of a loan's total cost over a year.
Unlike the interest rate, which only shows the cost of borrowing, APR includes lender fees, giving you a clearer picture of what you'll actually pay.
For loans with variable interest rates, differing term lengths, or hidden fees, APR might not provide a clear comparison.

To ensure you’re choosing the best and most affordable loan for your business, you can’t overlook APR. But what is APR, and how can you use it to compare loan offers?

In this guide, we’ll look at APRs, how they work, and when to use these calculations for comparing loan options.

Table of Contents

What Is APR?
How To Compare Loan Offers Using APR
When You Should Not Use APR To Compare Loan Offers
The Bottom Line On Annual Percentage Rates
Annual Percentage Rate FAQs

What Is APR?

Annual percentage rate (APR) is the total cost of a loan over the course of one year. APR is calculated by adding the interest rate of the loan plus lender fees.

Interest Rates VS APR

The interest rate is the amount you pay to borrow money from a lender. The interest rate is a percentage of your borrowing amount and is added to the cost of your loan. When you repay your loan, payments are applied to the principal (the amount you borrowed) and the interest.

APR includes interest, but lender fees are also added to give a more comprehensive view of the cost of borrowing. APR gives a more accurate overall picture of the cost of your loan, so you can better understand what you’re able to afford and compare lenders to find the best option.

What Loan Fees Are Used To Calculate APR?

Small business loan fees are added to interest rates to calculate APR. Loan fees may include:

Origination Fee: An origination fee is charged by a lender for processing a new loan.
Closing Costs: Closing costs are administrative fees that are required to finalize a loan. Closing costs may include loan-packaging fees, commercial real estate appraisals, or business valuations.
Maintenance Fee: Lenders charge these fees to maintain your account throughout the duration of your loan.
Underwriting Fee: This fee is collected by the underwriters that review and verify your personal documents.
SBA Loan Guarantee Fee: Small Business Administration loans have guarantee fees that range from 0% – 3.75%. Fees are determined by the amount of your loan. You may also pay annual service fees from 0% – 0.55%. The SBA evaluates and updates these fees each fiscal year.

How To Compare Loan Offers Using APR

To compare loan offers using APR, you’ll need to know the principal, interest rate, and fees for each loan.

In this example, we’ll compare three $10k loans with a term length of 3 years. The first loan has an interest rate of 10% with no fees. The other loans have interest rates of 9% and additional fees. By calculating APR, you can determine the most affordable loan option for your business.

	Loan 1	Loan 2	Loan 3
Principal	$10K	$10K	$10K
Interest	10%	9%	9%
Fees	None	$400	$107
Term Length	3 years	3 years	3 years
APR	10%	11.70%	9.73%

Loan 1: Since there are no extra fees, the APR is the same as the interest rate — 10%.
Loan 2: While the interest rate is lower, this loan has fees of $400. Using this information, the APR is 11.7%, resulting in a higher annual cost of borrowing.
Loan 3: With lower fees than Loan 2 and a lower APR than Loan 1, the APR for Loan 3 is 9.73%, making this the most affordable option.

The formula for calculating APRs is a little tricky, but most lenders will calculate the APR of your potential loan for you. You can also use our calculators for traditional term loans, short-term loans, and merchant cash advances.

When You Should Not Use APR To Compare Loan Offers

There are going to be situations where APRs won’t be helpful for your loan comparison. Here’s when you should use other tools to compare your small business loan offers.

Variable Interest Rates

It is more difficult to calculate the APR for loans with variable interest rates. Since there is no consistent rate percentage to use, you aren’t able to calculate an exact rate.

Most lenders offer the current prime rate — the general fluctuating interest rate that banks use as a basis to set their own rates — plus a fee. This means that when the prime rate increases, so will the amount you pay per year.

You have to know whether your interest rate is fixed or variable before you make a decision on a loan.

Different Term Lengths

Since APR is a calculation of the total cost of a loan over one year, it’s not useful to use APR to compare two loans with different term lengths. A general rule of thumb is that the longer the term length of your loan, the more it’s going to cost.

Hidden Fees

Some lenders won’t include all of the fees in their APR calculations. To avoid this issue, ask the lender what fees are included in the APR.

Refinancing Or Prepayment

You’re going to pay most of the fees at the beginning of your loan term, but APRs calculate those fees as if they’re paid over the entire year and throughout the life of the loan. If you refinance your loan or prepay, you’ll end up paying more than the original APR reflected.

Differing Rates & Shorter Term Lengths

Lenders of merchant cash advances and short-term loans calculate the total cost of a loan differently than term lenders. The term lengths for these loans also tend to be less than a year, which defeats the purpose of calculating APR.

These different structures can cause a lot of confusion about the true cost of the loan. Before applying, make sure you understand how to calculate the effective APR, an estimated APR for short-term loans and MCAs.

The Bottom Line On Annual Percentage Rates

Because APRs include all fees, it’s one of the easiest and most transparent ways to communicate the cost of a loan. Make sure not to neglect this number when you’re comparing loans.

Unfortunately, APRs are not always going to be helpful, so make sure you choose the loan that works best for your business and current situation even if it isn’t the one with the best APR.

With an understanding of APR, you can now start comparing loans to find the right option for your business. Start your search with our picks for the best small business loans. Good luck!

Annual Percentage Rate FAQs

What is a good APR?

A good APR varies based on the financing product you choose, as well as other factors such as credit score.

For example, a good APR for a well-qualified borrower for a long-term loan averages around 10% to 12%, while a good APR for a business credit card is around 14% or lower.

How do you calculate APR for a small business loan?

To calculate the APR for your loan, add the interest rate and all fees. Divide this number by the principal amount of the loan. After you get this result, divide this number by the total number of days in the loan term. Multiply the result by the number of days in a year (365) and then multiply this number by 100 to calculate the percentage.

Note that there are different ways to calculate APRs for short-term loans and MCAs. You can also use a loan calculator or speak with your lender to bypass the formula and find out your APR.

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Kymberlin Bush

Expert Contributor

Kymberlin earned her Bachelor of Arts in Creative Writing from Pacific University in 2020 and resides in Portland, Oregon.

View Kymberlin Bush's professional experience on LinkedIn.

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