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.
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?
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|
|Term Length:||3 years||3 years||3 years|
- 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.
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!