What You Need To Know About Business Loan Rates & Fees
Searching for the perfect loan for your small business can seem like a daunting and confusing task. From merchant cash advances to lines of credit, there are many types of business loans available; all work a little differently, with each charging different costs and fees during the application and borrowing process.
The most effective way to get the best deal on a business loan is to educate yourself. If you want to ensure that you’ve found the perfect business loan (and aren’t paying too much for it), it’s important to know what kind of rates and fees a lender might charge. Below, we’ll explain everything you need to know about business loan rates and fees.
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Interest Rates Can Be Fixed Or Variable
Interest is, perhaps, the most common cost that comes with borrowing money. Interest is a percentage of the principal (the amount you initially borrowed) that is, in turn, added to the amount of money that you owe. At a fundamental level, this is how most lenders make their money.
Loans with fixed rates have predictable monthly payments. The interest rate quoted to you at the beginning of your loan will be the same as the one you have at the end of your loan, assuming you keep up with your payments.
On the other hand, a loan with variable rates can change over time, depending on current prime rates or other changes within the market.
It’s impossible to predict which type of interest rate will cost you less over time since a variable rate can fall just as easily as it can rise. The advantage of a fixed-rate loan is predictability; you’ll be able to plan for the payments more effectively.
. . . But Not All Loans Have Interest Rates
Surprised? Some loans, short-term loans in particular, usually last less than a year. These loans may not last long enough to generate enough interest to be a viable way to make money. Enter the factor rate.
Like interest rates, factor rates represent a percentage (note: factor rates are sometimes expressed as a decimal, i.e., 1.3) of your principal that is added to the principal to determine the total amount you owe. Unlike interest rates, a factor rate is only applied once. So if you borrow $10,000 at a factor rate of 1.3 (30% of the borrowing amount), you’ll owe $13,000 in total.
Factor rates have developed a bit of a negative reputation because their simplicity can hide just how expensive the money you’re borrowing is. It also makes it difficult to compare them to loans with interest rates; a 10% interest rate is not the same as a 10% factor rate.
The most common drawback to factor rates you’re likely to encounter is that they don’t account for early repayment. For example, if you paid off a loan with a six-month term in three months, you’d still owe the full amount determined by the factor rate. Some short-term lenders do offer early repayment incentives, however, so be sure you check out the fine print before you sign up.
Another problem opened up by the way factor rates are structured is called double-dipping. Essentially, it’s a situation in which you can end up paying interest upon interest if you take out a second short-term loan before you’ve paid off the first. If you foresee taking another loan out before you’ve paid off your first, make sure your lender waives the existing fees upon renewal. Otherwise, you could end up owing an absurd amount on your combined principals.
Other Fees Can Obscure The Cost Of Borrowing
Transparency is a rare commodity in the lending industry. Many lenders won’t disclose their interest or factor rates until your application is being processed. However, as rare as rate disclosures are, rarer still is the lender that cleanly lays out its entire fee structure.
There are many types of fees you could be charged, and not every lender charges the same fees. Ideally, you’ll want to work with a lender who piles on as few miscellaneous fees as possible.
Here are some of the more common ones.
This is a fee charged to cover the costs of assessing your loan application, whether you’re approved for a loan or not. Most lenders do not charge an application fee (or any fees) before you accept the loan, so consider your options very carefully before applying to a lender that does.
This fee, sometimes also referred to as a closing fee, is charged by the lender to cover the cost of processing and disbursing a loan. The fee is usually expressed as a percentage (ex: 4%), though it can also be a fixed fee (ex: $295). They typically range between 1%-9% of the borrowing amount. Unlike most fees, origination fees are typically deducted from your capital before loan disbursal.
For example, if you have a $10K loan with an origination fee of 4%, the lender will deduct $400 before wiring the other $9,600 along to you.
A draw fee is similar to an origination fee but is applicable instead for lines of credit. Like an origination fee, the draw fee is generally expressed as a percentage, which is deducted from the capital you’ve requested from your line of credit before disbursal.
SBA Loan Fees
The SBA’s lending programs can provide significant value to borrowers, but they do come with some additional costs. You may, for example, end up paying both a bank origination fee and an SBA origination fee.
Additionally, the SBA charges a guarantee fee on all SBA loans above $150K. This fee is initially paid by the lending bank, which has the option of passing the costs along to you.
Wire Transfer Fee
When you take out a loan, the lender will typically wire the money to your bank account via Automated Clearing House (ACH). Because the banks need to talk to each other to ensure the money is going to the right place and that no fraud is going on, this process usually takes between one and three days.
Some companies give you the option of wiring your funds via a bank wire transfer, which is faster than an ACH transfer. Wire transfers are more expensive than ACH transfers, though, so you’ll typically be required to pick up the cost.
Check Processing Fee
ACH transfers are commonly used to collect periodic repayments from the debtor’s bank account. Some lenders offer the option of paying by check, but you’ll have to pay a fee for the extra cost involved.
Servicing & Maintenance Costs
These are fees charged monthly, quarterly, or yearly to cover the costs associated with collecting payments, maintaining records, following up on delinquencies, plus any other costs associated with maintaining a term loan or line of credit.
Servicing fees are commonly lumped in with your periodic payments. For example, your loan provider might deduct a certain percentage of each payment before sending the rest on to the investor who owns your loan. However, you need to pay attention to a servicing or maintenance fee if it’s separate from your periodic repayments.
Late Payment Fee
Miss a payment deadline? Count on paying a late fee. Aside from the fee itself, a late payment may affect your personal or business credit score.
A prepayment penalty is a clause or condition that penalizes you for paying off your loan early. This penalty can take the form of a fee that’s levied against you if you pay your loan off before a minimum amount of time has passed. It can also, in the case of a fixed-rate loan, mean not pro-rating your loan.
Prepayment penalties exist because some lenders count on a minimum amount of return on their loan, and early repayment may mean the minimum interest they were expecting won’t have time to accumulate.
The APR Is A Good Way To Understand The True Borrowing Cost
If it sounds like it’s tough to compare loan products, especially between lenders, you’re absolutely right. There is, however, a measurement that tries to roll all of these factors into a single, convenient number: the annual percentage rate (APR). The lower the APR, the less expensive the loan is. Learn more about this rate in our Beginner’s Guide to APR.
If a lender doesn’t provide an APR for you, you can still figure it out. The formula itself is pretty complicated, but there are numerous calculators you can use online to help determine APRs, including our long-term, short-term, and MCA calculators.
. . . But The APR Isn’t Foolproof
As useful as APR can be for making loan comparisons, there are some situations in which APR may lead you astray. APR assumes regular, predictable behavior from both you and your loan.
The most common issue arises with variable interest rate loans. Since you won’t have that information to plug into your APR formula when you sign up for the loan, you’re only going to be able to land at a ballpark figure. Likewise, it doesn’t account for early repayment, late payments, or default. It also may not take into account some of the more exotic fees that lenders may charge.
Finally, APR can be a little wonky when you’re dealing with products that have terms lasting less than a year, particularly those with fixed fees. In situations where a loan has a fixed rate, in addition to the APR, you should look at other metrics, including the total cost of borrowing and the cents-on-the-dollar cost, which can give you a more holistic understanding of how much the loan will cost. Learn more about evaluating the cost of fixed-rate financing in our guide.
Finding the perfect business loan is not easy, but once you know what look for, the process is a little less stressful. Remember, the goal is to pay as little for the money you’re borrowing as possible. APRs, in particular, can be a useful tool for comparing loans, just make sure you don’t solely rely on them.
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