How To Compare The Costs Of Different Small Business Loans

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The increasing amount of options for small business loans is a blessing and a curse for potential applicants. Many of the newer options are easier to obtain and can accommodate various different cash flow situations. But having so much to choose from can make it difficult to determine that you have indeed found the best business loan for your needs. This is likely a common reason for someone to avoid business loans altogether: they are already so busy and therefore do not have the time to compare the costs of dozens of business loans. What’s even more confusing is the fact that different business lenders present their costs in different ways.

Rather than making a hasty decision, potential applicants should look into quicker ways to find their most affordable option. One of the best strategies is comparing a series of metrics that you can ask every business lender about before agreeing on an offer:

1. APR

This is arguably the most important metric to know when comparing business loans. The APR (annualized percentage rate) represents the interest rate combined with all other fees attached to the option at hand. So, whichever option has the lowest APR will cost you the least amount of money within a year’s time. In most cases, the lowest APR is your cheapest option overall. And while different business lenders may present their costs in different ways, the option that is presented with only its APR next to the amount will most likely be your cheapest. An offer that tries to skirt around its APR, on the other hand, is likely more expensive than it appears. For example, you might see two options presented in this manner:

  1. $25,000 loan. 30% APR.
  2. $25,000 loan, 23% interest rate. 4.2% origination fee.

Confusing, right? Why can’t every business loan option just be presented with its APR? The second option might come with its own advantages but in terms of cost, option one will most likely be your best bet. Since business term loans typically carry the lowest APRs, you might see a merchant cash advance or accounts receivable factoring presented with several features attached to it, like option number two. It’s always a good idea to compare APRs because certain options may seem very cheap due to features like “0% interest.” The APR is designed to be much less deceptive.

2. Total Cost Of Capital

The Total Cost of Capital (TCC) refers to the cost of receiving the funds you are borrowing. It incorporates interest and any other fees to reveal a total dollar cost, rather than a percentage. How is this different from an APR? The two are very similar but APR represents the total cost of the business loan within a year’s time. TCC refers to the total cost of the business loan throughout its entire term. This makes TCC extremely useful when comparing two options with similar interest and fees.

Sometimes, the option with the lower APR has a higher TCC. The option with the lower APR might have smaller monthly payments but another option might cost less overall. Your current cash flow scenario and future projections will tell you which advantage would be more beneficial for your business.

3. Total Fees Charged

Fees are used very deceptively in the business financing industry. Unlike interest, the total amount of fees attached to a business loan actually decreases the amount of money you end up receiving. For example, if you take out a $25,000 loan with a low interest rate but $2,000 in fees, you are technically only receiving $23,000. This can have a major impact on APR. Business loans with low interest rates tend to have higher fees, which makes an $1,000 difference in fees more important than an $1,000 difference in interest. So, if you are presented with two options that are $1,000 apart in interest as well as fees, the option with the lower fees will most likely be cheaper.

4. Average Monthly Payment Obligation

You have your monthly payment, and then you have your Average Monthly Payment Obligation. The former refers to how much money you will pay the business lender every month. The latter refers to the impact of repaying the business loan on your monthly cash flow as a whole. This is yet another valuable metric for unveiling the true cost of a business loan that might initially seem cheaper or more expensive due to an unconventional repayment structure, like daily payments instead of monthly. Your Average Monthly Payment Obligation reveals how much your monthly payment will effect revenue, operational funding, and other components of cash flow.

While all of these figures are undoubtedly important to consider, your decision will likely come down to one figure that, due to the nature of your business, is especially critical for your finances. So, before examining different options, you might want to determine what that figure is. Just like any other major business decision, this process is much easier when you know which factors deserve the most attention.

The post How To Compare The Costs Of Different Small Business Loans appeared first on United Capital Source.

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