How to Evaluate a Small Business Term Loan: APR, Repayment Schedule, Fees and Total Borrowing Cost

A low advertised rate does not always mean a great deal. Two loans can differ greatly in price, with one costing thousands more than the other. This guide shows you how to compare small business term loan rates and terms and see each loan's overall borrowing cost.

We skip the basics and instead show you what figures to ask for, what calculations to do, and how to make sure your business can afford to repay the loan.

What Makes a Business Term Loan Different?

A business term loan provides a defined amount of capital that is repaid over a stated period through scheduled payments. Because the amount, payment schedule, interest rate, and term are usually specified in advance, it can be compared more directly than some flexible or revenue-linked financing products.

You'll receive the full amount up front and repay it in installments on a fixed schedule. Usually, you'll pay both interest and principal at the same time, so the total amount owed will decrease over time.

Unlike a line of credit, once you have paid back any money, you won't be able to access it again. Unlike revenue-based lending products such as a merchant cash advance, payments will generally be consistent. This can help with budgeting, but if your sales are slow during the month, your payments won't decrease.

Lenders usually look at your cash flow, how long you've been trading, and your credit history when assessing your application. They may also look for security or a personal guarantee. These factors can play just as big a part in determining the rates and terms you get on your small business term loan as the lender's base rate.

Five Important Elements to Evaluate Before Accepting a Loan

When you review small business term loan rates and terms, these five items decide most of the real cost.

Annual Percentage Rate (APR)

APR expresses the annualized cost of borrowing and may include interest and certain mandatory fees. It can help compare similar loan offers, but business financing products may not follow the same disclosure rules as consumer loans. Ask the lender how the APR was calculated and whether every fee is included.

The annualized rate showing the overall cost, including fees. In the example above, using the factor rate of 1.2 to repay in 6 monthly installments would give an APR of approximately 65%

Interest rate

This is the percentage rate charged on the outstanding balance. This does not include most small business loan fees.

Factor rate

An amount multiplied by the money borrowed. For example, if you receive a gross advance of ( $50,000 ) at a factor rate of 1.20, the contractual payback is ( $60,000 ), before any separate fees. It is not annualized and does not indicate when you would repay the money.

The business may receive less than the gross advance if fees are deducted upfront.

For example:

• Gross advance: ( $50,000 )
• Origination fee: ( $1,500 )
• Net amount received: ( $48,500 )
• Contractual payback: ( $60,000 )

Interest rate vs. overall cost of the loan

The rate is the price you will pay per $1 per year. The actual cost of the business loan will be the sum of all repayments and fees minus the amount you borrowed. A longer loan period with a lower rate may actually cost more.

Loan period and repayment frequency

You will find that the repayments are lower with a longer loan period. The repayment frequency will also affect the loan. Monthly, weekly, and daily repayments can all affect your cash flow. A weekly payment may be smaller than a monthly payment, but the total cost and cash-flow effect depend on the interest calculation, payment timing, fees, and repayment schedule-

How do they calculate the interest?

Does the overall amount you repay change? When will the first repayment be due?

Is the business loan repayment schedule the same each time?

Origination and other fees

You'll usually face several charges when taking out a Small Business Loan. Ask for a full breakdown of charges and look out for:

• Origination or underwriting – often taken off your loan amount, meaning you will have less money
• Application, documentation, or closing fees.
• Servicing or account maintenance.
• Late payments or bounce-back charges.
• Lien or collateral fees.

Early repayment and prepayment conditions

Some lenders will not charge any additional fees for early repayment, whilst others will charge a prepayment fee or a minimum amount of interest. Ask whether early repayment will reduce the total interest you owe, as it may not under some agreements.

How to Calculate Your Total Business Loan Cost

Three factors matter when calculating how much you will repay on a business loan.

Principal and interest

The principal is the amount you are borrowing. Interest is what the lender charges you for borrowing their money. You pay this on the outstanding balance each period.With a standard amortizing loan, early payments generally contain more interest and less principal. Over time, the interest portion usually declines as the outstanding balance falls. Ask for the amortization schedule because some business loans use different repayment structures.

Monthly payment calculation

For a fixed-rate loan with equal payments, the standard formula is:

M = P \cdot \frac{r(1+r)^n}{(1+r)^n - 1}

• (M) = periodic payment
• (P) = principal borrowed
• (r) = periodic interest rate
• (n) = total number of payments

If the quoted interest rate is annual and payments are monthly:

r = annual interest rate (i)/12
                 

This formula assumes:

• r = Monthly interest rate
• i = Annual nominal interest rate
• 12 = Number of months in a year

Worked hypothetical example

This example is hypothetical and isn't a quote or Spartan Capital's terms. Assumptions: $100,000 borrowed, fixed rates, equal monthly payments, and origination fees deducted from proceeds.

Offer B provides a lower rate, lower fees, and a lower APR. It costs around an additional $1,198 a month. It still costs roughly $5,691, as it will take two years longer to pay off the debt. The initial payment on Offer B will also go toward the principal by $750, with $1,326 going to interest.

There isn't an obvious choice. Offer A will cost less in total but requires a higher monthly payment. Offer B will reduce the monthly outflow but will cost more in total.

Short-Term vs. Long-Term Business Financing

Short-term loans are typically paid back within a couple of years. Long-term loans are paid back over several years. Often the purpose of the loan determines the choice.

• Match the term with the life of the asset. Equipment or renovations that last 10 years should not be financed for a year, and short-term inventory should not be financed over 7 years.
• With shorter terms payments are bigger and the total interest is smaller.
• With longer terms, payments would be smaller and the total interest would be bigger.
• When choosing the term, check for the option of making early repayments. A longer term with no penalty can help you pay less each month, until you can pay more if you have it.

So, choosing a longer term doesn't mean lower borrowing costs; it means lower payments.

Questions to Ask a Business Lender Before Signing

Ask these questions when applying for a business loan:

1. What is the total amount that will need to be paid back, and what is the total cost of business loan (including any fees)?

2. What is the APR, and how has this been calculated?

3. Is the rate fixed or variable? If variable, what could affect this?

4. Are there any fees to pay on closing and throughout the term?

5. Can you pay back early? Will this reduce the interest?

6. Will you require any collateral, lien, or personal guarantees?

7. What happens if you cannot make a payment? Do you have any default or acceleration clauses?

8. Can you provide a full amortization schedule?

Next Steps

The best decisions come from comparing your small business term loan options based on overall cost, repayment amounts, and flexibility.

Planning a business investment? Explore Spartan Capital's business term loan options and understand your available financing terms.