You’ve probably encountered the term Annual Percentage Rate (APR) when considering various forms of financing. But what does the number really mean and how does it affect your small business finances? Understanding APR can help you plan ahead so you can compare offers and make more informed decisions.
What is APR?
The annual percentage rate (APR) is the rate you’re charged annually when you borrow funds, through a credit card, equipment financing, or a small business loan, to name a few. The benefit of using this calculation is that it typically includes fees in addition to interest rates. So if you’re deciding between several options, the APR can help you level the playing field and understand how all the associated costs are compiled into a single amount. Keeping track of various interest rates, fees, and additional charges can be difficult.
Find APR in our Glossary of Small Business Lending Terms! You’ll see definitions of common terminology in the lending industry like accounts receivable, business credit score, and cash flow.
How it Works
APR informs borrowers about the amount they’ll be paying on a yearly basis. APRs linked to loans can be either fixed or variable. A fixed APR does not change throughout the term, while a variable APR can. In any case, the lender must reveal the details to you, the borrower, so you can be prepared to make the associated payments.
The APR is a combination of the nominal interest rate, which is the base rate before any adjustments, plus all associated fees and additional costs. These could include origination fees, insurance, and service charges, among many others. So if you see two offers with the same nominal interest rates and regular payments, you can tell the difference in fee amounts by comparing the APRs.
In contrast to an effective annual rate (EAR), the APR does not account for compound interest so it might not reveal the whole story. For example, if a loan’s interest is compounded monthly by 1%, the APR would not incorporate those gradual increases. It is calculated under the assumption that the monthly interest remains constant.
When it comes to credit cards, companies can charge APR for various transactions, like purchases, cash advances, and balance transfers. In addition, these rates can change depending on promotions and offers. Read the terms and conditions to understand these policies before you start using the card.
How to Calculate It
On a conceptual level, the way APR works is by adding all the associated fees and costs to the original dollar amount, then dividing to get the new annual payment. This calculated payment will be more costly than the original one. Dividing the new number by the initial total amount (meaning without any additional fees) will leave you with the APR. Learn more about calculating APR on Investopedia.
There are many different resources that will help you calculate APR, such as spreadsheet formulas and equations you can follow by hand. Ultimately, though, it will depend on the specific terms and adjustments associated with your selected funding. Be sure to ask about how the amount was calculated if you’re unsure.
APR and Loans
When comparing lenders, you can use the APR to get a realistic idea of the loan’s impact on your small business’s cash flow. Knowing exactly what you’re expected to repay every year can help you plan ahead and see the big picture.
At SmartBiz®, we’re proud to help borrowers access transparent and affordable SBA 7(a) loans through our bank partners. Learn all about our rates and fees here and check out our Working Capital, Debt Refinance, and Commercial Real Estate loan calculators to see the APR and monthly payments associated with your specific loan amount.