In a short-term business loan of less than a year, you’ll never pay the full amount dictated by the APR. The interest charged for a one-month loan would be multiplied by 12 to calculate the APR. This can drive up the APR even though it won’t change the cost of the loan.
For a short-term loan, the finance charge is the more useful measure to analyze short-term loans. By comparing what you will actually pay versus a theoretical APR, you can see the true cost.
A $10,000 loan with $500 in origination fees and a 5% interest rate and a term of 1 year works out to an APR of 14.69%. The same loan with a two-year term has an APR of 10.07%. If you shorten the long term to 6 months, however, the APR jumps to 22.96%.
However, when you examine what you actually pay in fees and interest, you see the difference. With the one-year loan, you pay $772.90. With a two-year loan, your fees and interest would be $1,029.13. With a six-month loan, your cost of borrowing is $646.34. It’s the length of the loan that is the variable determining how much you’ll pay.
So, if APR isn’t the best metric to use, how do you compare short-term small business loans?