In part two of our four-part series about small business interest rates, we looked at the difference between simple and compound interest. In this section, we’ll explore the difference between monthly interest rates and Annual Percentage Rate (APR).
When shopping around for a business loan, many borrowers make their comparisons based on interest rates. That number is important, of course, but it leaves out some factors that could end up costing you more than you anticipate over the long-term. To better understand how much money you’ll actually be required to pay over the lifetime of your loan, comparing the Annual Percentage Rate (APR) is a better bet.
A monthly interest rate is simply how much interest you would be charged in one month. This doesn’t include any other charges associated with the loan, and it doesn’t show exactly how expensive a loan actually is. APR, on the other hand, is the percentage rate charged on a loan over the term of one year. APR includes interest, plus fees and additional costs associated with your loan. The APR will always be higher than the interest rate, and it can vary greatly from lender to lender.
When lenders advertise only a monthly interest rate, it can be deceiving. For example, a 10% monthly interest rate adds up to an annual interest rate of 120%. When a business owner compares loans based on interest rates alone, he or she might see what looks like a lower rate-10%-and mistakenly think that this loan product offers a better deal than a loan that’s advertised at 12% APR. Thus, the easiest way to compare the prices of loans across different products and lenders is to look at the APR.
According to the Federal Truth in Lending Act, a lender must inform you of the APR on your loan. However, many lenders advertise a monthly (or weekly) interest rate as a marketing tool to attract borrowers, and the APR is in the fine print. By looking at an interest rate, rather than the APR, you’re left to guess about additional loan costs, which may include one-time charges like origination and application fees, or recurring fees like a monthly service charge. It’s important to know what’s included in the cost of your loan, and examining the APR is the best way to do that.
In addition to interest rates and fees, the APR of a loan can also be affected by the following:
- Loan term: Because APR is calculated based on a 12-month period, the length of time you have to pay it back will affect how much interest you will pay over the life of your loan.
- Payment schedule: How often you make payments will affect how much interest is applied for each one.
- Interest calculations: Does the interest rate decline as the balance is paid off, or remain flat?
- Collateral: Some banks keep a percentage of your loan in an account as collateral-similar to an escrow account-which borrowers can’t access until the loan has been repaid.
If this all sounds overwhelming, it can be. That’s why there are great tools out there including NerdWallet’s Business Loan Calculator.By simply plugging in a few key pieces of information, you’ll be able to calculate the APR for any loan and compare the APR for several different lenders and loan types.
As a borrower, it’s up to you to do your homework before securing a loan. Read all documents carefully before signing anything; ask any questions you have no matter how obvious they may seem, and remember: if an advertised interest rate sounds like it’s too good to be true, read the fine print.
Next up, read part four of our series about small business interest rates to learn about the different types of small business loans available to borrowers and how they compare.
FAQs
To better understand how much money you'll actually be required to pay over the lifetime of your loan, comparing the Annual Percentage Rate (APR) is a better bet. A monthly interest rate is simply how much interest you would be charged in one month.
What is the difference between APR and monthly interest rate? ›
APR is the annual cost of a loan to a borrower — including fees. Like an interest rate, the APR is expressed as a percentage. Unlike an interest rate, however, it includes other charges or fees such as mortgage insurance, most closing costs, discount points and loan origination fees.
Should I go by APR or interest rate? ›
Interest rates are influenced by factors such as your credit score, the lender you work with, inflation and the broader economy. When comparing loan offers, it's best to compare APRs to get a fuller picture of the true cost of the financing.
What is a good interest rate on a small business loan? ›
A reasonable interest rate for a small business loan or line of credit is between 3% and 17%, while an SBA 7(a) loan rate is capped between 11.5% and 16.50%. However, you could expect to pay 56.1% APR or higher with a bad credit business loan.
What is the difference between APR and PA interest rate? ›
In terms of loans, APR is the annual rate of interest. PA pays attention to not only APR but also payment frequency, as well as the total number of payments over time (i.e., 360 monthly payments over thirty years).
What's better, monthly or annual interest? ›
However, savings accounts that pay interest annually typically offer more competitive interest rates because of the effect of compounded interest. In simple terms, rather than being paid out monthly, annual interest can accumulate over the year, potentially leading to higher returns on the sum you've invested.
What is the effect of a higher APR on a monthly payment? ›
The fees that factor into your APR usually include: Base interest rate: Your lender will charge you interest on the money you borrow and will use that interest rate when calculating your monthly payments. The higher your rate, the higher your monthly payments.
What is the current interest rate for a small business loan of $25000? ›
SBA 7(A) Fixed Interest Rates
| Loan Amount | Maximum Rate | Maximum Rate Allowed (w/ Current 8.5% Prime Rate) |
|---|
| $0 to $25,000 | Prime + 8% | 16.5% |
| $25,001 to $50,000 | Prime + 7% | 15.5% |
| $50,001 to $250,000 | Prime + 6% | 14.5% |
| Above $250,000 | Prime + 5% | 13.5% |
Jun 24, 2024
SBA Loans and the WSJ Prime Rate
These loans are usually based on the WSJ prime rate and the lender's margin, meaning that when the prime rate increases, so does the interest rate on the loan.
What is a typical small business loan term? ›
The typical term depends on the loan type, but generally ranges from short-term (under 3 years) for lines of credit to long-term (10+ years) for SBA 504 loans used for real estate.
Calculating your monthly APR rate can be done in three steps:
- Find your current APR and balance in your credit card statement.
- Divide your current APR by 12 (for the twelve months of the year) to find your monthly periodic rate.
- Multiply that number with the amount of your current balance.
Firstly, it allows them to pay off the loan more quickly, as a higher monthly payment means more money is being allocated towards the principal balance. Secondly, it helps them pay less overall for the cost of the loan and reduces the amount of interest accrued over time.
What is APR vs effective rate? ›
The bottom line. The main difference between APR and EAR is that APR is based on simple interest, while EAR takes compound interest into account. APR is most useful for evaluating mortgage and auto loans, while EAR (or APY) is most effective for evaluating frequently compounding loans such as credit cards.
What's a good APR for a mortgage? ›
Today's Average Mortgage Interest Rates by Term
| LOAN TERM | INTEREST RATE | APR |
|---|
| 30-Year Fixed | 6.60% | 6.61% |
| 15-Year Fixed | 5.71% | 5.74% |
| 30-Year Jumbo | 6.71% | 6.74% |
APR is short for Annual Percentage Rate and is a mix of different fees and interest you pay for the right to borrow money. The APR you receive is based on your credit score – the higher your score, the lower your APR. A good APR is around 22%, which is the current average for credit cards.
What's a good APR for a car? ›
The term "good APR" can vary based on several factors, including your credit score, the type of car you're financing (new or used), and the loan term. Generally, a good APR for a car loan might look something like this: Excellent Credit (750+): 3% or lower for new cars, 4% or lower for used cars.
Are APR and interest rate the same car loan? ›
The interest rate is the percentage charged on what you borrow from a lender. It's a simple percentage that represents how much you'll pay in interest. The APR, or the annual percentage rate, considers the interest rate as well as other borrowing fees such as prepaid finance charges.
