Watch any car commercial, and you’ll hear a string of rapidly-spoken terms and conditions at the end of the alluring tight turns through mountains and deserts. These terms are meant to be a brief (but not at all exhaustive) overview of financing rules, and they can be the difference between thinking you’ll actually get that nice, new sedan for $0 down and 0% interest and not.
Qualifications for cars are similar to some of the hurdles that small businesses need to overcome in getting funding for their company goals. You’ll probably hear about interest, but you might also get told of APR. “Aren’t they the same?” you may wonder. Not quite. Here’s what you need to know about each, and why they are often conflated – but shouldn’t be.
What’s an Interest Rate?
In simplest terms, the interest rate is the cost of borrowing money. Whether you choose a small business loan or a credit card, this is usually expressed in a percentage of the total amount borrowed. A 10% interest rate on $100 would be $10 after the calculation period or term. (Interest rates are usually referred to in years, so you would only pay that full $10 if you waited an entire year to pay off any of the money – an unlikely scenario since most loans require payment right away.)
In some very unique cases, there are interest terms that are not annual. Certain “cash in a flash” or payday lenders may have interest rates that apply to a two-week period or perhaps a month. A 10% interest rate, in this case, means you are paying considerably more to borrow money. Always be aware of how long your interest rate is calculated to cover. For most legitimate business loans and credit cards, this is annual, but never take for granted that it is. Read the terms of your borrowing contract for full details.
What’s an APR (Annual Percentage Rate)?
A term that means almost the same thing as interest is the APR. As the full name implies, this is an interest rate calculated over the term of a year. In the case of the payday lender mentioned above, a 10% interest rate for two weeks would result in an incredible 260% APR, if the balance of the loan were carried over again and again for a full year. (Because of recent truth in lending laws, this information is more prominently displayed than it once was. Borrowers are now alerted to both the interest rate and the APR when talking about loans of the short-term variety.)
How Do They Differ?
For business loans and credit cards, the APR and the interest rate can be the same. Credit cards rarely differ between the two. Where there is more likely to be a discrepancy is with loans. In the consumer world, we see this all the time with mortgages. Since mortgages include an annual borrowing cost and a whole slate of additional fees, the APR will include the fees. So, APR may be the same as interest rate, but it will never be lower.
Many small business loans charge origination fees, which can range from 1-8% of the total loan amount. Some lenders will deduct this from the money before it’s delivered to the borrower. Others will work it into the payment plan, raising the annual amount paid to borrow and inflating the APR to be higher than the original interest rate. Whether the lender then charges interest on that fee is up to them. Always check your loan terms to see how interest, APR, and principal compare and know what you can do to get more money from your original loan amount.
How to Get a Lower APR
Since many loan products are similar, there may be just one important factor separating Bank A’s offer of a business loan from Bank B’s offer: the APR. All things being equal, it makes sense that you’d want to pay less to borrow the same amount of money.
Thankfully, there are steps you can start taking right now to ensure a lower interest rate and APR down the road – even if you’re not in the market for a loan at the moment. Using existing credit responsibly is the most important thing you can do. It’s also wise to:
- Limit credit applications and business transactions that will result in a hard inquiry on your credit score (this can include applying for insurance or a property lease)
- Make payments on time
- Keep your utilization of credit used to available credit low. If you have one card nearly maxed out, for example, but other cards have no balance, look into shuffling some of that debt to create a lower utilization rate on all your cards. Having a maxed-out card is a red flag for lenders and can cause them only to offer the highest of interest rates
- Check both your personal and business credit scores. See if any derogatory marks can cause a lender to look on you unfavorably. As with personal credit, those with stellar business credit scores can get access to the best APR’s.
Will Rates Go Up?
As the FED quibbles on whether to raise rates again this year, everyone (even those with amazing credit) are holding their breath on a potential a bump in APR. Unfortunately, there’s nothing anyone can do about this type of interest increase, as Prime rates are federally regulated. There may be something you can do about arbitrary or volunteer rates increases, however. If you have been making your payments on time and have an improving credit score, call up your bank and ask if they can do anything to lower your rates. You’d be surprised at how many are willing to do so.
If nothing else, let them know of any appealing balance transfer offers you may have gotten from other banks, and tell them that you’d rather not move your business away but need to consider the cost of credit. Sometimes, this is all they need to cut your rate by a bit, saving you money without all the effort of a transfer.
This article was originally written on November 27, 2018 and updated on December 10, 2020.