Small business loans provide the backbone for companies to start up and get off the ground. However, not all business loans are created equal and the choice of which lender to borrow from can have a major influence on a company's financial health.
Much like a homeowner will prioritize a home loan with a lower interest rate, so too will a lower interest rate for a small business loan save a great deal of money. However, interest rate may not always be as important as the annual percentage rate, or APR. What should you know about the two numbers?
Annual percentage rate refers to the total costs that a loan holder will pay over the course of a full year. Like interest rate, it is measured as a percentage of the total loan. Unlike an interest rate, however, it incorporates many more financial factors, including mortgage insurance, closing costs, and miscellaneous fees like loan origination fees.
This means that a loan's APR will always be higher than the same loan's interest rate. APR exists due to the Federal Truth in Lending Act, which mandates that any lender disclose the full fees associated with their loan. The monthly payments towards a loan, however, is based upon interest rate, since the "extra" costs within an APR are paid up front.
Lenders typically advertise a loan based on interest rate alone. It makes sense for them to stick to this statistic: by "avoiding" the discussion of APR fees, they can claim to have the lowest possible rates. Although this number is important, it leaves out the many contributing components that a loan holder will have to pay up.
As such, anyone interested in getting a small business loan will need to know the money they are required to pay back over the term of a loan. APR will change significantly from lender to lender, meaning that shopping around and getting the best deal will save a lot of money.
Lenders who market the monthly interest for their loans don't paint the entire picture of the obligation. A hypothetical 5% monthly interest rate means that there is an annual interest rate of 60%; a business owner who is looking around at rates and checking only the interest might be fooled into thinking that this loan will be cheaper for them than an APR of 6%.
However, the "extra" 1% in the APR might conceal a lower base interest rate. A lender is legally required to inform a borrower of the APR on their loan. Nevertheless, most lenders prefer to jam the APR into the small print of the loan and instead put the interest rate detail up front. This conceals the costs of fees, including recurring fees that might sneak under the radar.
When looking around for loans and comparing rates, a business owner should know if their loan's APR will be affected by different factors:
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