When entrepreneurs look to borrow money, the first number that catches their attention is always that of interest rates. While interest rates are critical, it is dangerous to concentrate attention on them alone. You want to know what you are really paying, so it’s necessary that you calculate the Annual Percentage Rate (APR). Computing APR is a key thing to consider, especially if it’s a business capital loan that you want to take. APR is intended to provide complete information for the borrower regarding the cost of funds. APR does not consider the promotional rate, along with charges like origination, administrative, and sometimes the effect of factor rates. For a business capital loan, APR provides the best means of comparison without surprises.
The Importance of The APR In Calculating The True Cost Of Borrowing
Only the base rate charged for borrowing is reflected in the interest rate. This means that lenders often make money by charging upfront fees or other types of pricing structures that can be used along with the interest rate to generate additional revenue. For example, a business capital loan at a low interest rate but with high origination fees may have a much higher total cost than a loan with a slightly higher rate but fewer fees. If you only looked at the interest rate, you would think you were getting a better deal than you really are. The APR is important because it combines all of the costs of borrowing into a single yearly pie chart percentage that allows you to see the total cost of your loan regardless of whether you are looking at a conventional business capital loan or a short-term financing option, allowing you to make an apple to apple comparison when determining which lender has the best loan product for you.
The Main Components That Impact APR
Calculating the real APR of a Business capital loan requires you to consider, among other things:
- Interest Rate: It is the rate that represents the cost of money charged to the borrower.
- Origination Fees: Typically, processing or underwriting a loan, these are one-time charges.
- Factor Rate: This is a measure used in alternative financing; instead of interest accumulation, the loan amount is multiplied by a certain figure.
- Repayment Term: Even if the total interest paid may be the least, shorter terms tend to have higher APRs.
Basically, combining all of these factors results in the cost of your business capital loan per year.
Understanding Factor Rates and Their Effects
Factor rates sometimes used for short-term funding can be confusing for borrowers. What borrowers actually pay is no longer calculated using an interest rate; instead, a factor rate such as 1.25 is used on top of the borrowed amount. This can lead to a high APR regardless of whether it’s short-term business funding. For instance, if a company takes a loan of $100,000 with a factor rate of 1.25, it ends up repaying $125,000, without consideration of the time taken to repay the loan. The same applies to APR, and in most cases, it ends up being higher than expected. It is, therefore, important to consider the factor rate in the assessment of any business capital loan.
How To Determine Your Actual Average Annual Percentage Rate (APR)
APR calculations may appear complicated, but the concept is very straightforward.
- You will first sum up the total fees and total repayment amounts.
- Next, you will subtract the initial loan amount from that sum to determine the total cost of borrowing.
- Finally, you will convert that figure into a yearly percentage rate (APR) for the duration of the loan term.
Although online calculators for APR calculations are useful, knowing your input information will help ensure accurate calculation of your actual rate. When used properly, each calculator’s results (actual rates) will indicate whether or not a business capital loan is adequately affordable or is going to be overly costly.
Effectively Comparing Loan Choices
However, APR becomes most beneficial when comparing different sources of funds. It can happen that the business capital loan might show a slightly higher rate of interest with a lower APR, or it might be higher when it comes to working capital loans with faster approval time. Focusing on APR instead of surface-level rates allows businessmen to make informed decisions and protect their cash flow.
Conclusion
When looking at interest rates, it is important to take all rates into consideration together as a total cost involved, which is reflected within the APR (Annual Percentage Rate) associated with that loan. Knowing an accurate APR, along with any additional costs such as loan processing fees and factoring fees, will help business owners make informed decisions when evaluating a business capital loan without risk of a costly error. The bottom line? Understanding the APR is critical to the long-term success of U.S. businesses!