Thursday, May 4, 2017

How Much is a Small Business Loan? Our Product-by-Product Chart Breaks It Down

You know the saying too well: “It takes money to make money.”

Sometimes you just need extra capital to grow your business. If you’re not willing to give up equity in your company or don’t qualify for small business grants, then taking on a business loan could be the way to go.

However, business loans certainly aren’t free money to use as you please for your business.

You, the borrower, have to pay your lender interest or some sort of fee for access to capital. And while some business loans offer cash at a relatively affordable interest rate, some small business loans come piled with sky-high rates—and can really put a dent in a business’s pockets.

So, how much is a small business loan really? Which ones are most affordable, and which ones should you avoid at all costs?

We’ll break how much a small business loan really is—product by product.

How Much is a Small Business Loan? Here are the Numbers You Need to Know

If you’re looking for the cost of a small business loan, it really depends on what kind of small business loan you’re talking about.

From traditional term loans to merchant cash advances, there are a whole variety of ways to finance a business these days. Check out this cost chart to find exactly how much each small business loan will cost, product-by-product.

7% – 8%
5 to 25 years
7% – 30%
1 to 5 years
Bi-monthly or monthly
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7% – 80%
6 months to 5 years
Weekly, bi-monthly, or monthly
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10% – 110%
3 to 18 months
Daily or weekly
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10% – 65%
The time it takes your customer to pay the invoice
Invoice financing company collects the money they’re owed once your customer pays the invoice
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8% – 30%
1 to 5 years
40% – 350%
Automatically deducted through your merchant account until you’ve repaid in full
Daily or weekly
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APR vs. Interest Rates: Why You Should Care About APR

When you think about the cost of just about any financial product—business loans included—the first term that comes to mind is probably an “interest rate.”

But you might have noticed that the business loan costs we quoted in that chart were listed as annual percentage rates (APR)—not interest rates.

When it comes to taking a complete look at exactly how much a small business loan will cost, it’s important to look at APR.

Here’s why.

APR vs. Interest Rates

APR and interest rate are both measurements of the cost associated with borrowing money.

However, if you were to calculate a business loan’s interest rate versus that same loan’s APR, you’d actually get different numbers.

How is that possible?

Well, an interest rate is technically defined as the amount (expressed as a percentage) that a lender will charge on the principal (the loan amount) for the borrower’s use of the funds. It represents the cost you will pay to borrow money.

The catch here is that an interest rate represents the amount you’ll be charged for simply borrowing the capital. It does not include any other fees a lender might charge when you take out a business loan with them.

Depending on the lender you’re working with and the type of business loan you’re applying to, they might charge a few (or many) fees during the entire loan process—think documentation fees, origination fees, loan processing fees, late payment fees, prepayment penalties, etc.

That’s why a simple glance at interest rates doesn’t answer the question, “How much is a small business loan?”  

Fees associated with borrowing money in the form of a small business loan with absolutely make your loan more expensive than the loan’s interest rate will.

To get the full, honest picture of what a small business loan will cost, you have to look at the loan’s APR. APR is the total price of borrowing money expressed in terms of an interest rate. When you look at an APR, you know that you’re getting the cost of your business loan—interest rates and other fees included.

Because your interest rate just shows the base cost of borrowing money, it’ll show a prettier picture than your APR would—APRs are typically a quarter to even a half point higher than an interest rate would be.

How Much is an SBA Loan?

Starting with one of the most affordable loan products out there, the rate on an SBA loan typically ranges from 7% to 8% APR.

What goes into this low-cost APR?

To fully understand the exact SBA loan rates, you first need to understand how an SBA loan works.

SBA Loans: Why They’re So Affordable

SBA loans aren’t actually issued by the Small Business Administration.

Instead, they’re loans issued by a traditional bank, but guaranteed by the SBA—up to a certain percentage of the loan amount.

When the SBA guarantees a portion of the small business loan, they’re essentially reassuring the bank lender that they’ll get at least most of their money back in the case that you (the borrower) default on loan payments. This takes some off the risk of the bank’s shoulder, and banks in turn become more likely to lend to smaller, “riskier” businesses.

SBA loans are so affordable for two major reasons: First off, they’re loans issued from a bank—and bank loans are some of the most affordable financing products available. But secondly, the SBA’s guarantee encourages bank lenders to lend to small businesses at lower interest rates (because they have less risk in doing so).

What Goes Into Your SBA Loan Rate

The cost of an SBA loan is made up by a few different things.

The interest rate you’ll get on an SBA loan is determined by the current prime rate (now 3.75%) plus an allowable spread of rates that gets determined by the bank lender you’re working with. However, that bank is subject to a maximum rate they’re allowed to charge on top of the prime rate.

For the SBA’s most popular loan product, the 7(a) loan, a lender can charge no more than 2.25% on top of the prime rate for loans of less than 7 year maturities. 7(a) loans with more than 7 year maturities, the most a lender can charge on top of the prime rate is 2.75%.

But the reason why an SBA loan generally costs around 7% to 8% APR (not just around 6.5%), is because the SBA does charge at least one fee for guaranteeing the loan. Simple enough, this fee is called the guarantee fee.

The actual percentage that you’re charged in a guarantee fee depends on the loan’s maturity and the amount the SBA actually guarantees. If your SBA loan is less than $150,000, you won’t have to pay a guarantee fee.

Any loan that’s more than $150,000 with a maturity of one year or shorter will carry a guarantee fee of 0.25% of the portion guaranteed. Loans between $150,000 and $700,000 with terms of more than one year will have a guarantee fee of 3% of the guaranteed portion. SBA loans of $700,000 or more will have a guarantee fee of 3.5% of the guaranteed portion.

So when it comes to the APR on a SBA loan, the guarantee fee gets factored in such that the range of cost is 7% to 8%.

How Much is a Medium-Term Loan?

Moving right down the list of affordable loan products, a medium-term loan from an online lender ranges from 8% to 30% APR.

When it comes to the cost of a medium-term loan, there isn’t too much to explain—a term loan is one of the most straightforward types of financing available.

In almost every case, a medium-term loan will come with a fixed interest rate that gets charged on the principal of the loan amount. And with most medium-term loans, you’ll pay the lender back with fixed monthly payments. Your repayment to the medium-term lender will again, not only include interest repayments. Any fees (documentation fees, loan processing fees, underwriting fees, origination fees, etc.) will also be factored into the APR of a medium-term loan.  

Medium-term loans from online lenders are, in structure, most comparable to traditional term loans you get from a bank.

However, you might notice that the cost of a medium-term loan, ranging from 8% to 30%, is a little bit higher than what you’d find at a bank.

Here’s what’s behind that.

How are Medium-Term Loan Rates Set?

While medium-term loans are some of the most affordable financing products on the market, they’re still a little more expensive than what you’d find at a bank or with the SBA.

That’s largely due to two factors.

Whereas banks have notoriously tight credit for small business owners (only lending to the most qualified borrowers), online lenders offering medium-term loans will work with less-qualified borrowers.

That’s not to say that medium-term loans are easy to qualify for—they’re some of the harder online loans to score. However, medium-term lenders are more likely to work with borrowers without perfect credit scores, have less time in business, haven’t reached profitability yet, or are bringing in less in revenue.

And because medium-term lenders will work with slightly less qualified borrowers, they’ll charge a slightly higher interest rate. That slight increase in what they charge in interest rate compensates for the fact that they’re lending to riskier borrowers. In the absolute worst case you can’t pay back your loan, the lender has already gotten a fair amount of the money they lent back via higher interest payments.

Another reason why your APR on a medium-term loan might be slightly higher than what you’d get from a bank loan is due to the time it takes for a medium-term lender to fund your loan.

Whereas a bank takes a long time to fund (a few weeks to a few months), medium-term lenders use technology to fund loans in a maximum of two weeks. You’ll of course pay for this speedy time-to-funding with higher interest rates.

How Much is a Business Line of Credit?

You might have noticed that the cost of a business line of credit can really vary—anywhere from 7% to 80% APR.

The wide range of costs for business lines of credit comes from the fact that there are two variations on a general business line of credit.

And while it’s not an industry standard, sometimes it makes sense to break down business lines of credit into two buckets: short-term lines of credit and medium-term lines of credit.

Business lines of credit don’t really have “terms”—you can draw from your credit line and pay your lender back, borrowing from them indefinitely (as long as the lender thinks you’ll remain a responsible borrower). However, separating business lines of credit like this helps to compare them to short-term loans and medium-term loans—at least in amounts, interest rates, and time to funding.

Medium-term lines of credit are, you guessed it, comparable to medium-term business loans. They’ll have large capital amounts, a lower interest rate (starting at 8% APR), and a slightly longer time to funding.

Short-term lines of credit are like short-term loans in that they offer fast, more accessible capital, but they’ll come with high interest rates (think up to 80% APR for shorter-term lines of credit).

Traditional banks and some online lenders (like Lending Club and Fundation) offer affordable medium-term lines of credit. However, these lines of credit are much harder to qualify for and take a longer time to fund. If you aren’t the most qualified borrower, or you need fast access to financing, short-term lines of credit make a lot of sense. Lenders like Kabbage and BlueVine are well-known short-term line of credit lenders.

How Much is a Short-Term Loan?

Short-term loans are more costly than their medium- or longer-term counterparts: rates start at around 10% APR, but they can go way up to the triple digits.

Short-term loans can be the quick capital you need to seize a one-in-a-lifetime opportunity or cover an unexpected business emergency. However, fast cash is expensive cash. And it’s important to note that, if you don’t have the strongest credit score, a long time in business, annual revenue, etc., short-term loans can come with steep APRs.

Plus, they’re paid back over a much shorter time frame (anywhere from 3 to 18 months) with either daily or weekly payments. This shorter term means that each payment will be pretty steep—and that can really cut into your business’s cash flow.

But expensive debt can be better than no debt if your business really needs the money to grow—if you’re confident you can pay it back.

What if I Get Quoted a Factor Rate?

Some short-term lenders will quote the cost of the loan as a factor rate (like 1.2) instead of an interest rate (like 10%).

The many different ways a lender can quote a loan’s cost is what makes the small business lending space confusing. But if you know the lingo you’re working with, you can get an understanding of the true cost of your loan.

The same goes for factor rates.

A factor rate on a short-term loan is simply a multiplier that tells you the total amount you’ll pay the lender back.

So, say you were quoted a factor rate of 1.35 on a $10,000 short-term loan over a 12 month term.

The total amount you’d repay is $13,500 ($10,000 x 1.35).

While it looks like your interest rate is 35%, that’s not the right way to convert factor rates to interest. The interest cost is 35% of the total loan amount, but with factor rates, here’s the catch: All of the interest is charged to the principal when the loan or advance is originated (unlike a loan quoted with APR, where interest accrues on the principal amount as it gets smaller and smaller as more payments are made).

How Much is Invoice Financing?

At the end of the day, the cost of invoice financing comes out to about a 10% to 65% APR. However, there are nuances to cost structure of this financing product.

Here’s how it works:

With invoice financing, an invoice financing company advances you a percentage of the value of your outstanding invoice—usually around 85%. Say you have a $100,000 outstanding invoice.

The financing company will advance you $85,000, holding the remaining $15,000 in reserve. Some invoice financing companies will charge a processing fee (usually around 3%) on the reserve amount right away.

Now, you wait for your customer to pay their invoice (while you use the advanced cash for your business). Every week that it takes your customer to pay their invoice, the invoice financing company will charge what’s usually called a “factor fee” on the reserve they’re holding—in this case, the $15,000 reserve.

So say your customer pays back in 2 weeks, and the invoice financing company was charging a 1% factor fee each week. In this example, they’ll take 2% of the total invoice amount, or $2,000, in factor fees. When you get the remaining reserve back, you’ll end up with $10,000 after the company takes the 2% in factor fees and 3% in a processing fee.

Essentially, the cost of invoice financing is simply a convenience cost you need to pay in exchange for getting the cash you’re owed now rather than later.

How Much is Equipment Financing?

Equipment financing helps you pay for the new or used equipment your business needs over time, instead of fronting the entire cost of your equipment in one purchase.

However, because an equipment financing company is loaning you money that you can use to purchase the equipment, you’ll be paying more to finance that equipment than you would be if you were to pay for it out of pocket.

The tradeoff makes sense for businesses that can’t afford that kind of large expense or don’t want to deplete their cash cushion with such a large purchase.

The APR range on equipment financing varies from 8% to 30%, with your actual rate depending on the equipment you’re buying and your qualifications.

Other than that, the cost structure to equipment financing isn’t too complicated.

Take, for instance, an equipment loan of $10,000 offered at rate of 12% over a 3 year term.

With a 12% APR, your $10,000 piece of equipment will end up costing you $11,957.15 all in (with monthly payments of $332.14).

How Much is a Merchant Cash Advance?

The last spot on our small business loan cost list is left for the most expensive product on the market—a merchant cash advance.

A merchant cash advance will almost always be a small business owner’s most expensive financing option—with APRs in the triple digits.

Let’s break down how much a merchant cash advance could really cost you with an example.

Say you’re advanced $40,000 with a factor rate of 1.20. (The cost of a merchant cash advance is almost always quoted as a factor rate.)

Using your factor rate formula, take $40,000 multiplied by 1.20—$4,800. That amount is what you’ll pay the merchant cash advance company back by allowing them to take a fixed percentage of your daily credit card sales.

Again, looks can be deceiving here. At first glance, you might think that your interest rate is 20%.

But you have to convert the factor rate into APR.

Say that, in this example, you’re allowing the merchant cash advance company to take 20% of your future credit card sales, and you expect to bring in $45,000 a month in credit card transactions.

You’d repay your merchant cash advance in 160 days with daily payments of $300. And when it all comes out, that merchant cash advance held a 85.43% APR—a little bit higher than that 20% interest rate you originally thought.

If you want to see just how expensive your merchant cash advance can be, check out this free merchant cash advance calculator and crunch the numbers yourself.

How Much is Your Small Business Loan?

There you have it—the total cost range of a small business loan, product by product.

While we listed out the general ranges you can expect to see for each business loan product, the APR you get quoted on your financing will depend on your business’s (and your personal) qualifications.

As always, do your homework to make sure that you’re getting the lowest-rate possible on your financing. If you don’t shop your options, you’ll never know if you can get a lower rate with a different loan or a different lender!

The post How Much is a Small Business Loan? Our Product-by-Product Chart Breaks It Down appeared first on Fundera Ledger.

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