by Meredith Wood
Shopping for a small business loan can be confusing in a number of ways. Trying to figure out what lender and loan product to go with, how much you need to borrow, and how to get your business finances in great shape can feel overwhelming enough.
And then, when you go to compare prices between various loans, you may find yourself in over your head. You may be asking yourself, “How do I compare these interest rates? What do all these fees mean? How do I figure out exactly what this loan is going to cost?”
To save you some headache and help you determine the true cost of borrowing as you shop for a loan, let’s break down the different fees that could be associated with your small business loan.
An origination fee is used to mitigate costs for financial institutions. You will not pay this, however, unless you officially take the loan from the lender. This fee can either be listed as a flat dollar amount or as a percentage of the principal.
Keep in mind, though, that not all lenders charge an origination fee, and those that do, vary in cost. Check with your individual lender to ask about any origination fees that may be associated with your loan. In the end, it might make one lender more expensive than another.
Guarantee fees are associated with SBA loans, which are loans provided by a financial institution but guaranteed in part by the U.S. Small Business Administration in order to decrease the risk to the lender.
The good news for borrowers is that because of this guarantee, lenders are more lenient with approving loans for small business owners who have less cash flow or less established credit.
However, the SBA assesses a guarantee fee that is charged to the lender, who may choose to pass it along to you at closing. The guarantee fee is based upon the maturity of the loan and the dollar amount guaranteed, not on the total amount of the loan. This can be a bit confusing to calculate, so if you’re applying for an SBA loan, ask your lender to break down any guarantee fees you’ll incur and how they will impact your total loan cost.
Check processing fee
As a means to keep their rates low, lenders will directly connect to your bank account and automatically process your monthly loan payments. If you’d rather pay by check, your lender may charge a check processing fee to cover added costs.
Late payment fee
It’s never a good idea to miss a payment. Not only does it hurt your credit score—it will also end up costing you more in the long run. To account for unexpected events, some lenders will offer a grace period. Just try not to turn that grace period into a habit.
Missed payments come with late payment fees, so to avoid it, make your loan payments on time.
In theory, paying your loan off early seems like a good decision. You’d no longer have that debt hanging over your head, and you could save some money on the interest rate, right?
Be careful, though. Depending on your loan agreement, you could face a penalty charge for doing so. This fee could potentially cost you more than the interest saved, so it’s best to do the math beforehand.
If you can, try avoiding small business loans that have prepayment penalties, as these penalties could prevent you from refinancing your loan in the future (or just paying it off completely, if that’s your plan). If you want to leave your options open, look for a small business loan that doesn’t come with these fees.
Account for fees and differing interest rates with effective APR
Accounting for all the fees that may be associated with your loan will help you to determine your true cost of borrowing. While keeping track of these different fees can be complicated, you can get a solid idea of the your total cost of borrowing by asking your lender for the loan’s annual percentage rate.
The APR will tell you the true cost of borrowing, showing you not only your monthly payments but also the total cost of your loan throughout the course of a year. And because the APR takes into account different interest compounding rates and includes any fees that are associated with the loan, you can compare the APR of various loan products and know that you’re comparing apples to apples.
Some lenders don’t advertise the APR on their loans outright, but they’ll usually provide it if you ask. And if they don’t, you can always use an APR calculator to determine your true cost of borrowing.
It can be intimidating and time-consuming to understand all the various aspects of every small business loan product. But by taking the time to do your research before you sign the dotted line, you could be saving your business significant headache as well as thousands of dollars in future unexpected loan costs.
Meredith Wood is the editor-in-chief at Fundera, an online marketplace for small business loans that matches business owners with the best funding providers for their business. Prior to Fundera, Meredith was the CCO at Funding Gates. She is a resident Finance Advisor on American Express OPEN Forum and an avid business writer. Her advice consistently appears on such sites as Yahoo!, Fox Business, Amex OPEN, AllBusiness, and many more.