Understanding business loan terms: what every small business owner should know
When you're evaluating a business loan offer, the terminology can feel overwhelming. Lenders use specific terms that aren't always intuitive, and understanding them is crucial for making informed decisions about your business financing.
APR vs. Factor Rate
One of the most common sources of confusion is the difference between APR (Annual Percentage Rate) and factor rate.
APR represents the true annual cost of borrowing, including interest and fees, expressed as a percentage. This is the standard way traditional bank loans are priced.
Factor rate, on the other hand, is a decimal multiplier used primarily by merchant cash advance providers. A factor rate of 1.25 means you'll repay $1.25 for every $1 borrowed. While this seems simple, it can obscure the true cost of the loan, especially for shorter terms.
Common Fees to Watch For
Beyond interest, many business loans include additional fees:
- Origination fees: Charged upfront, typically 1-5% of the loan amount
- Underwriting fees: Cover the cost of evaluating your application
- Prepayment penalties: Some lenders charge you for paying off early
- Late payment fees: Applied when payments are missed or delayed
Loan Covenants
Covenants are conditions you must maintain throughout the loan term. Common covenants include:
- Maintaining a minimum cash balance
- Meeting certain revenue thresholds
- Restrictions on taking additional debt
- Requirements to maintain insurance coverage
Violating covenants can trigger penalties or even loan acceleration (the entire balance becoming due immediately).
Getting Expert Help
Understanding these terms is just the beginning. Each loan offer is unique, and the true cost depends on your specific business situation. Working with a funding consultant can help you evaluate offers objectively and negotiate better terms.
If you're currently reviewing loan offers or preparing to seek funding, schedule a consultation to discuss your options.