On the face of it, a business loan seems relatively simple. You choose the amount you wish to borrow, the lender checks you’re eligible and, if you are, grants you the funds. You then pay them for their trouble via interest rates added to the loan amount. Straight forward? Not always.
If you’re venturing into business or are looking to re-finance an ongoing concern, understanding interest rates and knowing how to look for the best deal for your business banking facility or loan is a crucial skill.
Variable or fixed interest rate?
There’s no right or wrong answer here, but the key thing to bear in mind is that the interest rate option you choose will affect your repayments, the overall cost of the loan and the features made available to you.
The health or otherwise of your cash flow should be the key consideration here. A fixed rate will enable you to budget accurately, because you’ll pay the same amount each month, without fail. A variable rate will increase or decrease often with little prior warning. If your cash flow is good, you may feel you can take that risk and benefit from the times when the interest rate drops, but if you need tighter control on expenditure, a fixed rate is the way to go. But beware, if you are in a fixed rate contract and wish the ‘break’ the contract, the penalties can be high. If you are unsure, discuss this with your accountant or financial adviser.
Annual Percentage Rate (APR)
How do you know whether a daily rate of 0.005% is a better deal than 11/2% per month, or 12% per annum? What if the cheapest rate has the highest additional fees and charges? The answer is compare the annual percentage rate (APR). This includes total interest and all charges expressed as an annual percentage. It is a ‘benchmark’ which enables you to compare different products. The lower APR, the cheaper the total costs are. In the UK, lenders can quote daily, weekly, monthly or annual rates, but they must also quote the equivalent APR.
How to get the best loan deal for your business
Understanding the total cost of credit is very important when shopping for a business loan. I’ve got five tricks you can keep up your sleeve to avoid overcharging by lenders:
- It doesn’t finish with the interest rate. Lenders don’t just make their money via interest rates. Many loans will come with some form of one-off administration or application fee. There may even be on-going fees, such as service or account fees. Remember to factor these into the cost of the loan, along with any charges for early repayment. Also, make sure you check the APR.
- Don’t let low interest rates blind you. A low headline rate may look very enticing, but some lenders may often use it unfairly as a hook with which to draw you in before lumping on additional fees. There’s a simple mindset you can apply to avoid falling into this trap: if the interest rate looks too good to be true, it probably is. – Check the APR.
- Watch out for creative rate advertising. An interest rate of 0.05% per day sounds superb, doesn’t it? If you borrow £100,000, that’s only £50 per day! Grab the calculator – that works out at an annual interest rate of 18%, costing your business over £18k every year. All lenders must quote APR by law.
- You shouldn’t pay for credit you don’t use. Some lenders won’t refund you for credit you don’t use. This can be done in a number of ways, for example by charging you even if you don’t borrow (a non-utilisation fee) or by assuming an amount and duration for the loan and charging you upfront, regardless of how the loan pans out.
- High limits aren’t always what they seem. If a lender suggests you can borrow an amount which seems far too be good to be true, it probably is – proceed with caution. There will likely be strings attached such as the requirement to meet several tough conditions or pay an additional fee to access the maximum funds on offer.