By Carl Faulds
When you’re looking for a business loan, you naturally want to get the best deal possible. But with some lenders quoting APR and others a straightforward interest rate, it can sometimes feel like you’re comparing apples to oranges.
In this in-depth article, we’ll look at what the headline figures really mean—giving you the information you need to compare loans from different lenders so you can make an informed decision.
So, what’s an interest rate?
Interest rates affect every aspect of daily life. For example, when the Bank of England changes base rate, it automatically makes the evening news. If you get a letter in the post offering you a new credit card, there’s every chance it will have an interest-free period, quoted as 0%. Similarly, when you start looking around for a small business loan, you’ll encounter lots of different options with lots of different percentage rates.
Put simply, the interest rate is the percentage charged by a finance company for the privilege of borrowing their money—their profit, if you like. So if you borrow $50,000 over two years at an interest rate of 10%, with monthly payments and no arrangement fee, you’ll repay $2,307.25 a month, or a total of $55,374.00 over two years—that means interest of $5,374.00 on top of the capital you borrowed.
So, what’s an APR?
APR stands for Annual Percentage Rate, and it’s probably the most significant number you’ll encounter when seeking financing. Unlike a straightforward interest rate, an APR considers the full cost of taking out the loan, including arrangement fees and processing fees. If your lender won’t provide an APR, you should specifically request it, as it’s the most meaningful of all figures.
As an example, you might take out a $50,000 loan with a headline interest rate of 10% over a three-year term, with a 5% arrangement fee. The APR on this loan is 13.56%—a far cry from the 10% you were quoted. And where the APR differs from the simple interest rate, you may be certain that it will always be higher.
Comparing interest rates and APRs
Just to be confusing, some lenders usually quote a headline interest rate while others quote an APR. Let’s make some comparisons to show how wildly they can differ. Let’s say that Lender A offers you $50,000 over two years at an interest rate of 10% with an arrangement fee of 2%, and Lender B offers you the same $50,000 over the same two years at the same interest rate of 10%, but with an arrangement fee of 5%.
This is a no-brainer: Lender A has offered by far the better deal. When we translate these propositions, both with headline interest of 10%, into APR, Lender A is offering an APR of 14.05% (meaning you’ll repay $74,881.65 in total) while Lender B is offering an APR of 15.18% (meaning you’ll repay $78,739.10 in total). This is not a trivial difference, yet both loans have the same interest rate and Lender B’s offering seemingly attracts an arrangement fee that is only slightly higher.