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Small Business Loans: Are You Paying Too Much?

Chances are, as a small business owner, you know that getting a bank loan isn’t very easy these days. In fact, the number of small business loans in the United States still remains at below pre-recession levels.

One big reason for this is the strict regulations placed on traditional banks. For instance, the man-hours involved in processing a small business loan application simply makes the return on investment too low. In fact, many banks can’t make any money at all by lending to small business owners. As a result, many small businesses in need of loans, for things like expanding to a larger location or increasing inventory to seize an opportunity, have had to look outside of traditional banks.

Fortunately, there are alternative lending options, many of which are from very reputable lenders offering competitive rates for small business loans. That being said, it’s important to do your homework on the different lenders and be sure you understand the fine print on their total cost.

Teamwork in the officeAll Interest Rates Are Not Created Equal

There are three main types of alternative lending products. Most borrowers look for the lowest interest rate but fail to really understand what the respective type of interest or factor rate might mean to the total cost over the loan’s lifetime. Let’s take a closer look at three different types of alternative lending products and the difference between them:

1. A merchant cash advance or MCA: This is where the company buys your future credit card receivables at a discount. The average or typical MCA product generally carries a 1.38 factor rate (meaning for $100,000 proceeds, you will repay $138,000) and the repayment is generally set to be quicker than the typical pre-computed or simple interest loan product.

2. Pre-computed interest business loans: With this approach, the interest payments for the entire length of the loan are pre-calculated from the day you borrow and added to the total loan amount. This calculated interest is due over the lifetime of the loan and will not change. The downside to this approach is that even if the loan is paid off early, the full interest must still be paid in full.

3. Simple interest: This approach calculates the interest due on the loan by the principle balance outstanding each day. Therefore, as the loan amount decreases (generally daily with a daily loan payment), so does the interest.

Awareness of the various interest options can help save small business owners money and is critical in determining how much you are actually paying for the loan overall.

The overall cost of the loan can differ greatly based on the type of financing product. So, is it as simple as asking what type of interest is on a loan? Here are some additional questions to ask your lender that will save you money and help uncover the true total cost of your small business loan:

  1. Including ALL fees and interest – what is my TOTAL COST for the funds? (To calculate a factor rate comparison, divide the total of payments into the net loan amount on EACH of the transactions you are trying to compare)
  2. How long or what is my expected repayment period? If I pre-pay my loan, will I pay less interest or get a reduction in my total repayment?

The good news is that there are options these days for small business loans outside of traditional banks. While navigating alternative lending options and understanding their terms require some effort, a little knowledge can go a long way in saving money. And, that’s money you can use elsewhere to grow your business.