The Different Types of Interest Explained
We are most commonly aware of percentage rates being presented to us as an annual percentage rate (APR). Small business loan lenders are sometimes using "factor rates" which are expressed as a decimal (ie 1.3).
See the range of business loan interest rates.
Factor rates are expressed as a decimal figure rather than a percentage. The full amount of the interest is charged to the principal when the loan or advance is originated. Note: Additional fees are not included in the factor rate calculation but are included in the APR.
Annual Percentage Rate (APR)
An annual percentage rate (APR) is the annual rate charged for borrowing. It is expressed as a percentage that represents the actual yearly cost of funds over the term of a loan and includes frequency of compounding and ALL fees and charges.
Interest rate is the annualised interest rate. This is the annual rate charged, expressed as a percentage of principal, by a lender to a borrower. This rate does not include the frequency of compounding of any fees or charges. (APR does).
Before you sign the dotted line for finance for your small business, consider comparing the differences between finance products and lenders. Lenders that provide you with a SMART Box allow you to easily compare different lenders and/or products in a standardised language.
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How the calculator works
First we calculate the interest payable by multiplying the loan amount by the factor rate and calculating the difference [i.e. 20,000 x 1.3 = 26,000, interest = $6,000].
Then we divide the interest by the loan amount to get a decimal [i.e. $6,000 / 20,000 = 0.3]. We want to know what the interest rate is when annualised, so we multiple this decimal by 365 [i.e. 0.3 x 365 = 109.5]. We then divide this by the term (in days) [i.e. 109.5 / 180 = 0.6083] which is 60.83% – the annualised interest rate.
To calculate the APR (annual percentage rate) we use the frequency of repayments as how frequently interest on the loan compounds (daily, weekly, fortnightly or monthly). We then calculate the number of payments [i.e. 130 daily repayments for a 180 day term, based on ~22 repayments per month], repayment amount [i.e. $199.73 per day] and interest per frequency [i.e. 0.42% per day] to build an amortisation schedule to calculate the effective APR [i.e. 0.42 x 22 x 12 = 110.88%].
Finally we calculate the fees and charges payable over a year [i.e. $620]. This is then divided by the loan amount [i.e. 620 / 20,000 = 0.031]. And then multiplied by 365 [i.e. 0.031 x 365 = 11.315]. And then divided by the term in days [i.e. 11.315 / 180 = 0.0629] which is 6.29%. This figure is added to the effective APR we calculated earlier [i.e. 110.88 + 6.28 = 117.16%] to give us our final effective APR.
If you’re concerned about a factor rate, rest assures there are plenty of other small business loans you can get, for instance: