How to Compare Business Lending Costs
When you’re comparing financing offers for your business, the lowest number on the page isn’t necessarily the lowest-cost option.
A 12% interest rate, a 1.12 factor rate, and an 18% rate on a revolving line of credit measure cost differently. You can’t compare them at face value.
Instead, start with four questions: How much cash will you actually receive? How much will you pay in total? When will you have to pay it back? And what other fees apply?
Those answers give you a much clearer picture of what the financing will actually cost.
Know the terms
- Interest rate: The percentage charged on borrowed money. Depending on the financing structure, fees may be separate.
- APR: An annualized measure of borrowing cost that incorporates interest and certain fees. It can help you compare financing with different terms on a more consistent basis.
- Factor rate: A multiplier used to calculate your repayment amount. A 1.12 factor rate on $100,000 means you repay $112,000, before any separate fees.
- Effective cost of capital: What it actually costs your business to use the money for the period you need it.
Start With the Cash You’ll Actually Receive
A $100,000 financing offer doesn't always mean $100,000 will land in your account. Suppose a lender deducts a $2,000 fee when the financing is funded. Your business receives $98,000. That matters if you need the full $100,000 to buy materials, make payroll, add inventory, or take on a new order.
An offer that looks large enough on paper could still leave you short. Before comparing rates, make sure you're comparing options that give you the same amount of usable cash.
Then Look at What You’ll Pay in Total
Once you know how much money you'll actually receive, look at what you'll pay to use it. Factor rates are a good example of why this matters. Suppose you're offered a $100,000 advance with a 1.12 factor rate:
$100,000 × 1.12 = $112,000
You'll repay $112,000, which means the financing costs $12,000 before any additional fees. But a 1.12 factor rate is not the same thing as a 12% annual interest rate. A factor rate establishes a repayment amount based on the original advance. Interest generally accrues on an outstanding balance over time.
Rather than trying to compare those two headline numbers, ask a simpler question: How many dollars am I getting, and how many dollars will I need to pay back?
Consider When You Have to Pay It Back
Say you're a manufacturer buying materials today for an order your customer won't pay for another 90 days. Financing that requires weekly payments beginning immediately will affect your cash flow differently from financing that lets you repay on a schedule that better aligns with when cash comes into the business.
Neither structure is automatically better. What matters is how well the repayment schedule fits the way your business operates. Look at when payments begin, how often they're due, and what happens if your customers pay earlier or later than expected.
<H2> Don’t Forget the Fees
The headline rate is only part of the cost. Before you compare offers, find out what other charges apply and when you'll pay them.
Look for:
- Origination and documentation fees: Are they added to what you owe or deducted before you receive the money?
- Draw fees: Will you pay a fee each time you draw down funds from a line of credit?
- Facility or maintenance fees: How are they calculated, and do they apply when you aren't using the line?
- Collateral or account costs: Are there appraisal, reporting, renewal, or other costs?
- Early repayment terms: Will paying early reduce your cost, or will some charges stay the same?
- Late-payment terms: What changes if you need the money longer than expected?
You don't need to become a lending expert. You just need enough information to understand what you'll pay based on how you expect to use the financing.
Put APR in Context
APR can be useful because it puts borrowing costs on an annualized basis, helping you compare financing with different rates, fees, and repayment periods. But don't stop there.
You also want to know the total dollar cost, the amount of usable cash you'll receive, and whether the payment schedule fits your cash flow. A financing option can look attractive on an annualized basis but still create pressure if payments come due before your customers typically pay.
That's why it's useful to consider your effective cost of capital: what will it actually cost your business to access the amount of money you need for the period you expect to use it?
A Simple Way to Compare Business Financing Offers
If you have several offers in front of you, put them on the same footing before making a decision:
- Start with the same amount of usable cash. Make sure each option gives you the amount your business actually needs after upfront fees.
- Calculate your expected dollar cost. Include interest or financing charges along with applicable fees.
- Map out the payments. Look at when repayment starts and how it lines up with money coming into the business.
- Consider what happens if your timing changes. Find out how your cost changes if you repay sooner or need the capital longer.
- Think about whether you'll need the capital again. A one-time financing need and a recurring working capital gap may call for different structures.
The goal isn't simply to find the cheapest rate. It's to understand what you're paying, what you're getting, and whether the financing fits the way your business actually operates.
When a Revolving Line of Credit May Be Worth Exploring
If you need capital for a one-time expense, one-time financing may be enough. But many growing businesses have working capital needs that repeat. You might need to purchase inventory before you can sell it, buy materials and pay employees before completing an order, or wait 30, 60, or 90 days for a customer to pay an invoice. Once one order is complete, the cycle starts again.
A revolving line of credit is designed for that kind of repeated use. You can draw funds when you need them, repay what you've borrowed, and borrow again within the terms of the line.
With an asset-based line of credit, eligible accounts receivable, inventory, or both can help determine how much capital is available. As the business and its eligible assets change, borrowing availability can change with them.
If you're comparing financing options, don't stop at the advertised rate. Look at what the capital will actually cost and how well the structure fits the way cash moves through your business.
[See how Aion's revolving line of credit works.]