There is some confusion about business loan interest rates. One of the biggest issues is how you express interest rates. Some companies express business loan interest rates as a simple interest rate. Others express interest rates as the annualised percentage rate (APR).
What is a simple interest rate?
Simple interest is a way of calculating interest rates. Here's an example. If you have a simple interest rate of 18.95%, a $50,000 loan over two years would cost you $18,950. So the total principal (the amount of the loan) and interest that's paid back is $68,950. We use the simple interest rate formula. This is Simple Interest = Principal x Rate x Time (in years).
When you apply the simple interest rate formula to our example we get: $50,000 x 18.95% x 2 = $18,950.
Simple interest is calculated on the premise that the entire loan amount is paid off in one lump sum at the end of the loan term. It doesn’t take principal repayments into account. Most business loans, however, have scheduled payments that reduce the outstanding amount over the loan term. So when a business loan is quoted with a simple interest rate, it hides the real cost.
What is APR?
The annual percentage rate (APR) is used to calculate the true cost of a loan.
Looking at the previous example. If you get a two-year $50,000 loan and the interest rate is 18.95% APR, with a repayment every fortnight and fortnightly compounding, the total interest is $10,252. So you will pay back is $60,252 in principal and interest. Take note of the difference between the total cost of credit with the simple interest rate and APR. This is $8,698 ($18,950 for the simple interest loan less $10,252 for the APR loan). As a result, the true cost of the simple interest loan is much higher.
If you convert the loan quoted at 18.95% simple interest into APR and base it on repayments each fortnight, the APR for the loan is 33.55%. Learn more about the business loan interest rate for various business finance products.
