Fundera Whiteboard Series: APR vs Cost of Capital

When making a decision between two small business funding options, you’ll often be asked if you prefer lower APR or a lower cost of capital.

But what does that actually mean?

APR or annual percentage rate (i.e. 15.18%), is the annual rate charged for a borrowing a sum of money. It’s standardized across the lending industry—and is the best metric for comparing loans, apples to apples.

The cost of capital (i.e. $1574.78) is the dollar amount you are paying to borrow a sum of money. It’s quoted as a dollar amount rather than a percent—and can be thought of as “the cost of borrowing money.”

Wouldn’t a loan with a lower APR have a lower cost of capital? Not quite.

Let’s See Why!

Loan A

$10000 Principal
12% Interest Rate
2-year term
5% Origination Fee
15.18% APR
$470.73 Monthly payment
$1797.63 Cost of Capital

Loan B
$10000 Principal
10% Interest Rate
3-yearterm
5% Origination Fee
13.56% APR
$322.67 Monthly payment
$2,116.19 Cost of Capital

You’ll see that Loan A has a higher APR and higher monthly payments, but the loan has a lower cost of capital.

Loan B has a lower APR and lower monthly payments, but has an overall higher cost of capital.

To choose between these options, you’d need to ask yourself:

Do you want lower payments or a lower total cost of a loan?

If you want smaller payments, choose the loan with the lower APR. If you to pay less overall, choose the loan with the lower cost of capital.

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from Fundera Ledger https://www.fundera.com/blog/fundera-whiteboard-series-apr-vs-cost-capital