If you're looking for a business loan, you're probably always asking yourself one all-important question:

How much will this cost me?

Too many people think that you can find the answer in your loan's interest rate, but there's actually more to the story. In order to figure out how much that debt financing will cost--and to compare different loans to decide which is the better deal--you'll want to calculate your APR.

Let's talk through what APR is, how it's different from an interest rate, and why you need to know it before taking on any loans.

The Definition of APR

Here's the simple definition: A loan's APR is its annualized cost, or how much you'll wind up paying for that capital averaged out to a year. But how does it actually work?

APR stands for "Annual Percentage Rate," which might sound a lot like "interest rate," but they're different in a very important way. Here's how:

Interest Rate vs. Annual Percentage Rate

An interest rate is just one expense that lenders charge you for borrowing. It's almost always in the form of a percentage of your loan amount and it indicates the amount of interest you'll repay during the duration of your financing.

For example, if you take out a loan of $150,000 with a 10% interest rate and a monthly repayment schedule, you'll pay 10% interest each month--on top of the principal payment, which is a portion of the amount you borrowed.

But APR takes into account every expense that lenders tack onto your loan--including, but not limited to, the interest rate. Two loans of the same amount, for the same term length, and with the same interest rate can have wildly different APRs, just thanks to their other fees.

What Else Does APR Include?

APR takes a loan's interest rate into account, but it also incorporates the other expenses, fees, and charges that lenders add onto your financing. From more to less common, your loan's APR could include these additional costs:

  • Origination fee
  • Underwriting fee
  • Loan processing fee
  • Private mortgage insurance fee (if applicable)
  • Document preparation fee
  • Loan application fee

Always make sure to ask your lender what they include in their APR calculation.

2 Ways to Find Out Your APR

Now that you understand what an APR is--the true, all-inclusive cost of a loan--you should know how to figure it out. Here are 2 ways to do just that:

1. Ask Your Lender

If you're working with a reputable lender, simply ask them what your loan offer's APR is. Some lenders don't quote APRs because they want to hide their other fees, but if you ask and they refuse to disclose the annual percentage rate, then you'll know you're working with an untrustworthy business.

You might want to calculate the loan's APR on your own, too, but asking your lender is always a good first step.

2. Use an APR Calculator

The internet has plenty of business loan APR calculators for you to plug the specifics of your financing into. Ideally, you'll want calculators that take the kind of loan you're looking for into account, since a short-term business loan works very different from invoice financing, for example. Here's a standard, easy-to-use term loan APR calculator.

As you can see, it takes into account not just your loan amount, term, payment schedule, and interest rate, but also a few common fees associated with business loans. Even if you trust the lender you're working with, it's never a bad idea to double-check their calculations. And if you're juggling multiple loan offers, the right set of APR calculators can help you understand what each option costs.

How APR Can Help You Compare Offers

By now, you've seen how a loan's APR is the most accurate way of expressing its true cost, because it takes every expense your business will have into account. That doesn't mean you shouldn't pay attention to interest rates, but it does mean that comparing APRs will help you determine which loans will ultimately cost your business the least.

By incorporating all expenses tied to a loan, from its interest rate to its smallest fees, APR gives you the chance to put your financing options on the same playing field. It's much easier to compare 12% APR with 15% APR than two interest rates, term lengths, and an array of other fees.

With that said, the lowest APR loan isn't necessarily your best choice--even if it's more affordable.

Why not?

It's simply because a loan's APR can't account for your specific business's needs. Sometimes you might be willing to pay more for a loan if it fills a certain gap in your finances. For example, a super-affordable real estate loan might have an incredibly low APR, but if you're looking to finance a batch of inventory then it's just not a sensible debt to take on.

Use APR to weigh your options carefully, but in the end, it's up to you--not a number--to understand what your small business needs to grow.

 

Published on: Aug 30, 2016
The opinions expressed here by Inc.com columnists are their own, not those of Inc.com.