With the explosion of alternative lenders offering small business loans, there is a plethora of funding options out there. Unfortunately, unscrupulous lenders are taking advantage of entrepreneurs who might not fully understand how to determine the true cost of a loan.
An expensive loan can sink a small business and trap them in a spiral of borrowing to pay the bills. On the other hand, a low-cost loan, like an SBA loan, can fuel growth and help small business owners save money by refinancing expensive debt.
Here’s what you need to know to determine how much your loan actually costs so that you don’t get ripped off!
What is ‘Interest’?
Interest is the charge for the privilege of borrowing money, typically expressed as annual percentage rate (APR). If you’re a small business owner, it’s important to understand APR and how it affects the total cost of your loan. The APR represents the true cost of a loan. It differs from the interest rate because APR includes all fees associated with the loan, such as origination fees and monthly maintenance charges.
There are lots of online calculators out there to help you figure out what you’ll pay. We like NerdWallet’s Business Loan Calculator here.
Other Factors to Consider
In addition to factoring the loan constant or the APR there are other aspects to consider before taking out a loan. Small business owners should compare the upfront lender fees required when borrowing as well as prepayment penalties. Also, check with the lender to see if they report to the credit bureaus. Loan information not provided to credit bureaus could prevent a small business from building credit to qualify for a future loan.
There are a few factors other than the APR you need to consider when searching for a low-cost small business loan.
Fees and charges: Ask about early-prepayment penalties, application fees and other costs.
Type of interest rate: The APR can either be fixed or variable. Make sure you understand this or the APR can skyrocket, putting your cash flow at risk.
Application speed: If you need quick cash, speed might be the most important factor. A lender should be able to tell you how long the process will take after your loan is approved.
Lender reputation: Check unbiased reviews, articles and other resources like TrustPilot to vet your lender. If you’re finding unhappy customers, beware.
Reporting to credit bureaus: Make sure your lender reports payment activity to the credit bureaus. This will help you establish strong business credit, vital when shopping for a lower-cost loan in the future.
The Bottom Line
Research, research, research. If you’re interested in growth and savings, take out an affordable loan that won’t hurt your cash flow. If it’s confusing to calculate monthly or annual payments with a particular lender, take a step back and consider other options.
The best way to secure a low-cost loan is to have a healthy credit score. The higher your score, the better rates and terms. Take advantage of free resources to help you through the lending process. Reach out to local small business support groups or find a successful small business mentor to guide you through the lending process.