More than 29% of new small businesses fail because they run out of capital. Getting a business loan is an excellent way to maintain operations and keep your business on the way to profitability.
But applying for and getting a loan is not free. All loans carry a specific interest rate, which will vary based on the strength of your business and the risk that the lender incurs. On top of the interest rate, there are also different types of loan fees that you have to pay.
Loan fees can be confusing and complex, so it's essential to understand what type of fees you will have to pay, the terminology, and how much the entire loan will cost your business. Reading the fine print and asking the right questions can save you a lot of hassle and help you make the right financing decision.
Read on to learn more about what loan fees you may face in the process and what that means for the total cost of your loan.
What Are Business Loan Closing Costs?
Closing fees are the costs of taking out a loan. These include your application fee, origination, processing, appraisal fees, and anything else you must pay to get the loan.
Closing costs also refer to commercial real estate appraisals and any other business valuation your lender must do to approve your loan.
Often, loan officers or staff mention that you must pay closing costs. However, they’re not necessarily going to break down the details of the costs — so it’s up to you to know exactly what they entail.
Understanding that closing costs refer to all fees you will pay can help you better negotiate your loan and, ideally, pay fewer business loan fees.
Difference Between a Business Loan Interest Rate and Annual Percentage Rate
When you apply for a small business loan, you will see both your interest rate listed and something called the annual percentage rate or APR. Both are expressed in percentages, so many borrowers view them interchangeably.
But the interest rate and the APR aren’t the same things. The APR reflects what you’ll pay in interest and fees. Understanding which costs represent your interest rate and APR allows you to distinguish better the amount you will pay in interest rate fees, business closing costs, and other fees. Let's dig deeper into the differences and how they affect your small business loan.
1. Interest Rates
The lender charges the interest rate to lend you the principal amount (the amount you borrow).
So if, for example, you are getting a business loan with a principal of $100,000 and your interest rate is 8%, you’d be charged 8% on your loan balance each period. Your balance starts at $100,000 and decreases as you make payments.
A lower rate will make your debt more affordable. The rate of your small business loan interest rate depends on a variety of factors, such as:
- Your lender and their rates. For example, small business loans from traditional banks and credit unions often have lower interest rates than online business loans.
- The type of loan you are getting. You could get a lower interest rate loan, such as an SBA 7(a) loan, while loans with invoice factoring or a line of credit might have higher interest rates.
- Your business's financial situation. Lenders may charge higher interest rates if your business isn't making as much profit as it should or if your credit score is low.
- Available collateral. If you borrow a large sum, you might need to use a valuable asset as collateral. Depending on the value of your collateral, your interest rate may change. High-value collateral like real estate might help you get a lower interest rate.
2. Annual Percentage Rate (APR)
You won't pay all your fees immediately when you take out a loan. These fees will be spread out over the entire duration of your loan, and your lender will add them to the interest rate.
As with interest rate charges, business loan fees can also be charged as a percentage of your principal. When you add fees and the interest rate together, you get the Annual Percentage Rate or APR.
Let's get back to our $100,000 business loan example. On top of your 8% interest rate, you might also have to pay 2% in fees. So the APR is 10%.
How high or low the APR depends on several factors. You will have a higher APR if you take out a short-term loan. That's because the APR is spread out over the duration of your loan, so a shorter repayment period means a higher APR percentage. It also depends on what specific fees the lender charges.
Understanding the difference between interest rates and APR can help you distinguish the true cost of your business loan. You can also avoid being caught unprepared for how much you’ll pay.
Types of Business Loan Fees
While most financial institutions will lump closing fees together and present them as one number, it's good to understand each business loan fee and its role. So let's look at different types of loan fees that are applicable for a small business loan.
1. Application fees
When you look for business funding and apply for a loan, you might be charged a loan application fee. This one-time fee covers the cost of processing your application, getting the necessary documents, and analyzing your credit score.
2. Origination fees
Origination fees are usually a percentage of your total loan amount. Your origination fee could be as low as 0.5% or as high as 2%. These fees cover the cost of taking out the business loan, such as underwriting or funding costs.
3. Packaging fees
Similar to origination fees, some institutions charge a packaging fee. These fees cover various lender costs; some lenders charge a packaging fee instead of an origination fee. For example, the Small Business Administration (SBA) does not charge origination fees but does charge packaging fees.
4. Underwriting fees
Many lenders have to go through an underwriting analysis for your business to determine whether you should get the amount you asked for and what interest rate you should have. The underwriting fee is usually packaged in with origination fees.
5. Wire transfer fees
You can choose how to receive the funds if approved for financing. Lenders charge a wire transfer fee for that service when you choose a wire transfer.
6. Lines of credit annual fees
Many financial institutions will charge your business an annual fee, which could be a flat fee. This fee only serves to maintain your line of credit so it can stay open and active.
7. Late payment fees
You will have a set payment frequency when you take out your business loan, such as weekly or monthly payments. If you miss payments, you might have to pay late payment fees. This might be a flat fee or a percentage of the amount due for that period.
8. Non-sufficient funds (NSF) fees
If your loan payment is due and you don't have sufficient funds in your business account, you might be charged a non-sufficient funds (NSF) fee. You will still have to pay the regular loan and NSF fees.
9. Prepayment penalties
Most financial institutions want you to abide by the timeline you agree on when you take out the loan. They might charge you a prepayment fee if you want to pay your loan earlier. The reason is that the lender might lose a lot of interest money, so the prepayment penalty is supposed to cover those losses.
10. SBA Loan guarantee fees
You can get SBA loans from various lenders, but the SBA guarantees your lender will get 75% to 85% of the loan back, even if your business defaults on the loan. But because of this guarantee, the SBA charges a guarantee fee of around 2% to 3.75% of the loan amount.
Why Are Business Loan Closing Costs Important to Understand?
When looking for a loan to give you an influx of necessary cash or to grow your business, the true cost of your loan is often obscured. Without transparency, you could pay more for your financing than you need to.
You might see the interest rate and not worry about the rest. But to avoid hidden fees, you should ask for an explanation of all the costs of your loan. You also need to dive into the details of the closing costs when comparing loans to ensure you’re choosing the best one for you.
Innovative loan marketplaces now provide increased transparency by listing all loan fees, so you know exactly how much you will have to pay.
Only when you know your interest rate, APR, and business closing fees can you truly make an informed decision about which financing option is the best one for your business.
Conclusion
The process of getting a business loan to grow your business and fund new opportunities can be full of confusing financing jargon. Understanding business loans' ins and outs and costs can help you make better financing decisions.
If you’re looking for various business loans with transparent costs, explore the options on our innovative loan marketplace. With AdvancePoint Capital, you’ll find numerous choices that fit your needs.
And we make the process of applying for a loan simple. You can get a business loan in less than 24 hours with all the information you need on the true cost of your loan. Start growing your business — get a quote now!
