Applying for a small business loan can be something of a minefield. Whilst banks have been increasingly reluctant to lend since the financial crash of 2008, there is a plethora of other lenders keen to take on new business.
There are a number of alternative finance options, so it’s important to work out which is best for your business. This proliferation of choice can make comparing different lenders difficult – so how can you be sure you’re getting the best deal?
Make sure you find out the APR
To make sure you’re not comparing apples with oranges, it’s important that you find out the Annual Percentage Rate (APR) and not just the headline interest rate.
For example, you might decide to borrow £100,000 at an APR of 10%, with fixed repayments combining both capital and interest. In the first month, you might repay £12,000, consisting of £11,167 in capital and £833 in interest. In month two, you would also pay £12,000, but this would now consist of £11,260 in capital and £740 in interest, as the outstanding loan would have reduced to £88,333. Continue paying at this rate and your loan will be paid off in nine months, with total interest of only £4,100.
However, some lenders will cost a loan using a “factor rate”, which they won’t clearly differentiate from an APR. For example, you might be told that you can borrow at a factor rate of 1.1, meaning you will pay back £110,000. Does this mean the APR will also be 10%? Not at all. In fact, your APR would be a staggering 26.4%. Always ask lenders to quote the APR, so you can make a direct and meaningful comparison.
Find out if you can repay early without penalty
If your cash flow proves better than expected, you may be able to pay off the loan early and save yourself a fortune in interest. For this reason, you should make sure you take out a loan without penalties for early repayment – though once again, things are not quite as simple as that.
Some loans are clearly advertised as having no penalties, but still require you to pay the same total interest however quickly you clear the debt. Going back to the example above, if the loan were offered with simple, rather than calculated, interest, you could pay the £100,000 off after one month at a total cost of just £100,833.
With simple interest, you pay for the actual time you have the money. In contrast, calculated interest reflects the cost of borrowing for the full term of the loan, whenever you make the repayments. As a result, in our hypothetical example you would need to pay back £104,100, no matter how quickly you were able to repay.
Find out if there are any fees
If you’re borrowing through a broker, you may well have to pay a fee to access the finance. Some lenders also add “origination” or “packaging” fees to each loan they make.
In simple terms, an origination fee covers the work the broker or lender makes in finding the borrower and preparing the paperwork. These fees are often deducted upfront from the principal of the loan, meaning that if you take out a £10,000 loan with a £500 origination fee you will actually receive £9,500, though you will still pay interest on the full £10,000.
Make sure you read the fine print carefully, to ensure there are no nasty surprises, and directly ask lenders about fees and charges so you can meaningfully compare different loans.