A Beginner’s Guide to APR

You have probably come across the acronym APR sometime in your life. If you have taken out a mortgage, student loan, or have applied for credit cards, you have heard of an APR rate. When it comes to business loans, APRs also play an important role. If you have a full understanding of what APR is and you know how to calculate it, you can save a lot of money this way.

What is APR?

APR stands for annual percentage rate which is the true cost of borrowing money each year that is expressed as a percentage of the principal. This is different than an interest rate because APR takes into account any small business loan fees that lenders may charge you. An APR is generally higher than the interest rates since it factors in the interest rate and any extra costs or fees that are associated with your business loan.

APR terms can be either fixed or variable. A fixed APR means your APR will remain the same throughout the life of the loan. Bank loans and business term loans from online lenders typically have fixed APRs. A variable APR means that it can change throughout the life of the loan. Variable rates are mostly associated with credit cards or a business line of credit. Lending to small businesses is risky for lenders because the lender’s funds are less secure therefore APRs for small businesses tend to be somewhat higher than an APR for a personal loan.

Some business owners look for low monthly payments and interest rates only but understanding the APR can give you a better understanding of the loan cost. Some lenders may have low interest rates than others, but it might carry additional costs and fees that make the loan more expensive than a lender who has high interest rates but no additional costs and fees. Therefore it is important to compare the APR and not just the interest rate.

Lenders use factors like your personal credit history, state of residence, loan term, and approved loan amount to determine your APR for the loan. All lenders are required to disclose what your APR is when issuing a small business loan.

Traditional lenders such as banks or credit unions have APRs that range from 4% to 13% where alternative and online loans can have APRs that range from 7% to over 100%. Alternative and online lenders have higher interest rates than traditional lenders because they have fewer requirements and a fast underwriting process. Alternative and online lenders are generally better for businesses that are startups, have low business revenue, or applicants with low credit scores. It is recommended to go the traditional route and use alternative lenders as a last resort due to the high rates.

Calculating APR

In order to calculate APR, the following information is needed:

  • The interest rate (and how often it compounds)
  • Fees associated with the loan and the costs
  • The repayment term
  • The total loan amount

Your financial lender will determine what your APR is based on your financial history as well. Most lenders have a minimum credit score requirement to qualify for their loan. Your credit score will determine what interest rate you receive with higher scores generally translating to lower interest rates.

To learn if you are getting the best rate for your business you need to consider the following:

  • Compare APR quotes between different lenders: by comparing quotes between lenders you can determine if you are getting the best APR.
  • Consider monthly costs: the best small business loan is one that you can afford. Even though a lender might offer you a low APR, the monthly costs may be high which is not good for you and your business. Make sure you consider monthly costs to determine if the loan is right for you.

Other Factors Beyond APR

While it is important to compare APR quotes and consider monthly costs, there are other factors you should compare when choosing a lender.

Extra charges and fees: make sure to ask and understand all the fees you are being charged so you know what you are going to pay over the life of the loan. Some extra charges could be application fees, origination fees, packaging fees, closing costs, early-prepayment penalties, and late payment fees.

Type of interest rate: find out if the interest rate is fixed or variable.

Speed of application and funding: if you are looking for quick funding, make sure the process is speedy. Each lender should tell you how long the application process takes and how soon you can get the funds after approval.

Lender reputation: search for reviews online of the lender.

The Bottom Line

While APR provides you with a good framework when considering a loan offer, you also need to understand all the other factors and components of the loan to make sure it is the right decision for you and your business. These actions will help you qualify for more favorable terms.