Arguably the most confusing part of shopping for small business loans is comparing numbers. You can only make a decision after understanding the rates and fees for each option. This process becomes much less stressful when you are aware of every numerical figure that affects the cost of the business loan. It’s crucial to know this information before speaking to financial institutions. Many institutions will not reveal every rate and fee attached to their products unless you ask. When you know which questions to ask, shopping for small business loans can be as simple as researching your cheapest options, contacting different financial institutions and finding out how affordable they truly are, compared to what you’ve seen online.
Thankfully, the list of all rates and fees associated with most small business loans is not very long. The quicker you obtain this information from each institution, the less time it will take you to learn which option is the cheapest, overall and month-to-month.
Interest rates are how financial institutions make the bulk of their money off small business loans. It is a percentage that determines the total amount you owe along with how much you pay each month. Fees affect the total amount you owe as well but most fees are paid up front, where interest is tacked on to every monthly payment.
Potential borrowers are often so concerned about interest that they ignore the likelihood of fees. Financial institutions know this, and will sometimes advertise a product with a shockingly low interest rate. Such products are typically accompanied by high fees, but remember, the institution might not tell you that unless you ask. You may discover fees so high that they completely offset the low interest. So, do not be tempted into accepting a low interest rate, like 0%, without asking about fees beforehand.
If fees did not exist, you could find out the total cost of a business loan by looking at interest rates. But this is not the case, and that’s why APR (Annual Percentage Rate) was invented. APR incorporates interest and all fees to determine the total cost of the business loan within a year’s time. The lower the APR, the lower the total cost of the loan. For many borrowers, APR is the only thing they look at when comparing business loans, and this isn’t necessarily a bad idea. If you know what kind of business loan makes the most sense for your needs (business term loan, merchant cash advance, working capital loan, etc), the only remaining step might be figuring out which one is the cheapest.
Some business financing programs do not have the traditional repayment structure of a business term loan. Two popular examples are a merchant cash advance and accounts receivable factoring. Instead of an interest rate, these programs are accompanied by a factor rate that is presented in the form of a decimal (1.5%). With a merchant cash advance, the factor rate determines the total amount you owe. Multiplying your borrowing amount and the factor rate will produce this figure. There is also a retrieval rate, which determines how much will be deducted from your debit and/or credit card sales each day until the total amount is paid back in full.
Accounts receivable factoring is when a financial institution purchases an unpaid invoice for a discount price and pays the borrower just a few days later. The institution is then responsible for collecting the owed payment from your customer. Once the payment is collected, the institution pays you the remainder (from the discount), minus the factor rate.
Here are the most common fees attached to small business loans.
Application Fee: This is a fee for checking your credit score and processing your application. It is sometimes referred to as an “Origination Fee” and would theoretically be included in your APR. Some institutions split this into two fees: An Application Fee and a “Processing” Fee.
Document Preparation Fee: Some institutions charge a fee to pay for the cost of drafting documents related to the business loan. This would theoretically be included in your APR.
Prepayment Penalty: The institution loses money when you pay off your loan early and may therefore charge a fee to make up for the loss. This wouldn’t be included in your APR since it only applies to borrowers who pay off the debt in full before the agreed-upon due date. Some institutions charge prepayment penalties, others do not.
Late Payment Fee: This is a fee for making your monthly payment later than the agreed-upon due date.
Check Processing Fee: This fee is charged when you make a payment via check.
Small business owners may avoid business loans solely because they don’t have time to negotiate with different institutions. But since APR is by far the most important figure, the only negotiating you’ll be doing is asking for a lower APR. In the long run, an APR that is just one point lower than another can save you thousands of dollars.