APR represents the interest rate plus any fees that are either associated or attached to a loan. Evaluating any loan or financing product with an APR gives you a more complete version of the overall cost to your business, making it much easier to compare and contrast all of your options.
Although both APR and interest rates are expressed as a percentage, be careful to not think APR and interest rates are interchangeable. For example, a lending company providing a loan will typically express its charges as an interest rate along with any additional fees, like the origination fee. The APR is the sum of all of these costs.
Let’s break out what you need to know to fully understand APR. In this scenario, Jennie’s Jellies has been quoted with an interest rate of 11% from two competing lenders. Lender A includes fees of 2.5% while Lender B has an additional 4% in fees. While the interest rates are the same, the APR would be greater with Lender B. Fortunately, calculating APR doesn’t require a business loan interest calculator; it’s simple arithmetic ((interest rate + fees/ number of days in a term) X 365 ) X 100. While the fees can be a bit more challenging to calculate, the APR is simple to determine.
The Restrictions of APR
As with any cost expression, the practicality of APR only goes so far. Because of the way time impacts APR, it’s not always the most precise method of the total cost.
For example, the APR for a short term loan will naturally be higher than a long term loan. This happens because a long term loan spreads out the interest and fees over a period of years while a short term loan is more condensed. Still, this fact doesn’t make a short term loan more expensive than a long term loan. Given that a borrower has more time to repay the principal of the loan, there is also more time for the lender to generate more in interest charges.
For a short term loan specifically, the best approach is to consider how these funds will affect your bottom line. Will you be able to use these funds immediately? What is the opportunity cost of not securing this loan? What is your estimated return on investment? Ultimately, pursuing a loan should help your business drive growth.
As with any loan type, regardless of the final APR, you need to weigh whether or not your business can take on the payment. The last thing you want to happen is for the loan to become too much for the business. If you’re able to determine that these funds will help you achieve your goals, the higher, short term APR could be worth the greater upfront costs.
How Is Your Interest Rate and APR Determined?
Beyond the rates and fees that determine your total APR (which we’ll get into in the next section), there are a variety of other elements that determine your final APR, interest rate, factor rate or discount rate.
Let’s get more familiar with these factors:
Type of Loan
Depending on the type of loan you pursue or qualify for, the APR may naturally be higher or lower. For example, SBA loans are one of the most affordable loan options with a low APR thanks to its government guarantee.
Your Credit Score
For many lenders, a personal credit score of 650+ is indicative of someone who understands how to use their credit responsibly, meaning they’ll want to work with you. Simply put, the higher your credit score, the lower your rates and fees will be.
Health of Business
Much like your credit score, the longer you’ve been in business, the greater the likelihood that lenders will want to work with you. Typically, lenders want to see that applicants have at least 6 months in business, though companies with longer histories will receive more affordable offers.
While not all loans require collateral, you’ll likely find that the more collateral you post, the less expensive the loan will be. Collateral offers security to the lender in the event you’re unable to fulfill the terms of the loan. As a result, the lender feels more comfortable with more borrower-friendly terms.
How Quickly You Need Funding
Depending on how quickly you need the funds, you may need to work with a company who specializes in helping small businesses secure financing within days. In these scenarios, the borrower may pay additional costs for the convenience of receiving the loan as soon as possible.
Long term loans provide funding over an extended term. While short term loans do offer a smaller window for repayment, they aren’t as costly as a long term loan. Long term loans have more time to collect fees and interest from the borrower.