What Is APR?We give you the lowdown on APR and how it affects what you pay on your loans.
Whether you have credit card debt, a student loan, a mortgage, or any other kind of loan, you’ve probably seen APR, or annual percentage rate. But there’s a good chance you don’t know what it is or why an annual percentage should matter to you anyway.
We’re here to help. Because honestly, if you’re borrowing money (especially as a small-business owner), you need to understand APR and how it affects your loan cost.
We’ll dive into APR: what it is, what it isn’t, and how it works with business loans (and other types of credit).
Here we go!
The APR basics
APR stands for annual percentage rate—which probably doesn’t really clear anything up for you. So let’s break down what APR actually means.
APR is a way of talking about the total cost of a loan over one year, hence the “annual” in the acronym. Of course, when we talk about loan costs, most people’s minds immediately jump to interest.
Let’s get that out of the way: APR is not just a fancy synonym for your interest rate, or even your annual interest rate, though that’s an easy mistake to make. The interest rate is just one part (but a very important part) of APR. The rest? Other fees and charges.
In fact, the whole point of APR is that it’s a more accurate way to talk about loan cost than the interest rate alone. APR takes into account things like origination fees, processing fees, closing costs, and packaging fees—anything that adds to the total amount you’re paying for your loan. When you’re looking at APR as a percentage, like 7%, it’s basically telling you that over one year, you’ll pay 7% of your loan amount (principal) in interest and fees.
You know how a higher interest rate is worse than a low interest rate? Same with APR. Because APR is a percentage of your loan amount, a lower APR means you’re paying less in interest and fees over the course of one year.
So if you want to see the true cost of borrowing money, whether through a loan or credit, you need APR.
What APR doesn’t tell you
In theory, APR gives you an apples to apples comparison of loans—if you compare two loan offers, the one with the lower APR should be cheaper, right?
Not exactly. APR is a very useful tool, but it has some limitations that you should know about as you choose a business loan.
Like the fact that APR describes the yearly cost of a loan and not the total cost (it is annual percentage rate, after all). Two $100,000 loans with 5% APR can cost very different amounts in the long run if one of them has a 5-year loan term and one has a 10-year loan term. Because with the 10-year loan, you’re paying the same APR—but for twice as long.
Your loan amount is another thing to consider. A $50,000 loan with a 5% APR and a 10-year term will cost less than a $100,000 loan with a 5% APR and a 10-year term, simply because 5% of $50,000 is less than 5% of $100,000.
APR doesn’t necessarily include every fee under the sun. Things like late fees usually don’t fall under the APR umbrella, so you could end up paying more than expected.
So sure, if you have two otherwise identical loans that have different APRs, the one with the lower APR is a better deal. But when you take into account things like loan amounts and loan terms, suddenly APR doesn’t tell you as much as you might think it does.
That’s why we recommend using a business loan calculator before you accept a loan offer. It can help you understand the true cost of a loan—not just for one year, but over the entire lifecycle of the loan.
APR and business loans
APR applies to loans and credit of all types (including personal loans like your adjustable rate mortgage, car loan, and personal credit card accounts), but let’s take a quick look at APR and small-business loans.
If you’re wondering why APR has become the standard for comparing loan costs, look no further than the Truth in Lending Act. This 1968 law required lenders to start using the annual percentage rate to talk about loans (rather than misleading borrowers with other rate calculations).
Some loan types tend to have lower APRs than others. For example, SBA loan rates tend to be lower than non-SBA loan rates. Likewise, term loans usually have lower APR than lines of credit, which have lower APR than credit cards.
As you shop around for a loan, most lenders will give you a range for their business loan rates, so you can choose whether or not to apply. But you won’t know your actual APR until your loan application is approved.
In fact, several things can affect the APR a lender offers you, including term length (lenders usually offer lower APR on longer loans than short-term loans), your business’s credit history, and your personal credit score.
And again, we highly recommend you take the time to calculate the total cost of your loan rather than relying on APR alone. APR is a useful comparison tool, but it’s not the be-all and end-all.
Some lenders have started including a SMART Box on loan offers. This tool includes information about APR, but it provides a much more comprehensive explanation of your total loan cost. We love SMART Boxes.
FAQs about APR
What’s the average APR for business loans?
That’s tough to answer, and we’ve never found any credible stats. While we could make some wild guesses, remember that APR depends on everything from your loan type to your personal credit score. Better to look at the best rate you can get rather than worry about the average.
Don’t qualify for a business loan? Get a personal loan instead.
How can I get the best rate?
Well, for starters, you can make your loan application as strong as possible. Lenders usually give a lower interest rate (and therefore lower APR) to businesses with good credit history, high revenue, etc.
But that’s a long-term solution. If you want the best possible rate right now, we recommend using a lending marketplace like Lendio. It lets you compare loan offers from different lenders, so you can see what kinds of APRs are available to you.
What is effective APR?
Some types of business financing use a set rate (like a factor rate) or fees (like draw fees) instead of an interest rate. Because the interest rate is a fundamental part of APR calculations, and these types of financing don’t have an interest rate, you can’t calculate a true APR on those loans.
Instead, you can calculate “effective” APR, which is another way of showing the cost of a loan. But since these types of loans, like a payday loan or a merchant cash advance (MCA), tend to have really short repayment terms (less than a year), the APR looks ridiculously high—like 150% high.
And sure, MCAs are a pretty expensive way to borrow money, but mostly those high APRs just tell you that you’re paying everything back in a short period of time. (We explain this in more detail in our guide to merchant cash advances.)
In other words, you should be careful when you take out a loan with a high effective APR, but you should also make sure you understand what that effective APR is actually telling you.
Next time someone asks what APR is, you’ll have the answer. More importantly, you’ll have the know-how you need to compare your next credit offer, whether it’s a business loan, credit card, or mortgage loan. And that means you can make wiser decisions when it comes to taking on new debt.
Because while your annual rate won’t tell you everything you need to know as a borrower, it will tell you a lot.
Now that you understand APR, you’re ready to compare the best small-business loans and find the right one for your company.
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