When borrowing money for your business, you may have heard a few different terms surrounding your interest rate: the annual percentage rate (APR) and the actual cost of credit (ACC).
In general terms, these two are the same thing, but they’re not always synonymous with the loan or credit card’s interest rate. Knowing how to calculate each can help you better compare the different options you have for capital for your company.
What’s the difference between an APR and an interest rate?
In simple terms, the interest rate on a business loan or business credit card is the rate you pay each month on your balance. The rate is typically annualized to show how much interest you pay over the course of a year. But avoid confusing that rate with your annual percentage rate, which is also called the actual cost of credit.
In addition to the interest rate, your APR also includes any other fees or finance charges that you incur on the loan or card. In cases where there are no extra fees or charges, your APR will typically be the same as the stated interest rate.
But if your loan has an origination fee, the interest rate is only one component of your total costs over the life of the loan.
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How to calculate the APR of a business loan or credit card
Calculating your actual cost of credit sounds complicated, but it can be simple if you have the right information. The calculation is different for loans and credit cards, however, because credit cards are revolving credit with no defined repayment term.
How to calculate the APR on a business loan
Things can get a little complicated when calculating your APR on a loan with upfront fees. Let’s say you get approved for a loan of $10,000 over five years with a $212.47 monthly payment, a 10% interest rate, and a 5% origination fee.
Typically, an origination fee is deducted from the loan amount, giving you just $9,500 in cash. But since your monthly payments are still based on the $10,000 original loan amount, your APR will be 12.24%.
Instead of crunching the numbers yourself, you can use Nav’s term loan APR calculator or a time value of money calculator to get the APR for your specific loan.
How to calculate the APR on a business credit card
Since credit cards don’t account for compounding interest — there’s no set repayment period to calculate it — your APR is typically based on the financial institution’s prime rate plus its credit card interest rate, which can be based on your creditworthiness.
For example, the prime rate as of October 2018 is 5.25%, and if your bank’s interest rate for your credit card is 8.99%, the total APR would be 14.24%. Most credit cards have variable APRs, which means that it can change as the prime rate changes over time.
How to compare loans and credit cards based on the APR
The Truth in Lending Act requires that lenders disclose the APR on loans and credit cards before you apply. This means that you don’t need to calculate your actual cost of credit on every loan before you decide.
That said, a lender may not share the APR up front, instead laying out the interest rate and fees. In situations like this, you may need to look to the fine print to get an APR you can compare to other lenders. But in general, the rate you see when shopping online or at a bank is the actual cost of credit rather than just the interest rate.
The bottom line
Understanding the difference between an interest rate and an APR is important when you’re comparing business loan and credit card options. While these terms are often used interchangeably in the finance world, they’re not always the same.
As you shop around, make sure you’re not comparing apples to oranges and that the rate you see represents your total cost of credit rather than just a portion of it.
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