There are three things that most small business are short on: time, resources, and money. All things you need to get granular on decisions both big and small. That’s particularly true with regard to researching the best small business loans available to you, because the little details, such as simple interest rate vs. APR, can begin to feel like a big numbers game.
But not paying attention to these items can end up costing your company money down the line if you end up in a loan that’s more expensive than you’d anticipated. Understanding the difference between simple interest rates vs. APR takes a bit of nuance, but doing so can save you money on your loan in the long term.
Here, we’ll show you exactly how these two terms differ, how lenders determine these rates, and how you can calculate them on your own.
The important difference between simple interest rate vs. APR lies in how much your debt will end up costing you. The simple interest rate only accounts for the interest that your lender charges on the loan, and doesn’t include additional fees. The Annual Percentage Rate (APR) includes your annualized interest rate, plus whatever additional fees are attached to your loan. APR takes into account compound interest, amortization rates, and fees.
It’s easy to confuse the two terms. After all, both are expressed as a percentage of the principal you’re borrowing, and both indicate the amount of money you’ll need to pay your lender on top of that borrowed amount. But because your interest rate just shows the base cost of borrowing money, and your APR shows the total cost of borrowing money, your APR is typically higher than your interest rate.
Here’s a deeper dive on each:
A simple interest rate, aka a nominal interest rate, is (simply) the interest you’ll pay the lender in addition to the lump sum, or principal, you’re borrowing. That additional fee is how lenders make money off their loans. It’s expressed as a fixed percentage of that principal amount.
Here’s the formula to determine simple interest:
Simple interest = Principal x Interest Rate x Duration of Loan (Years)
So, if you’re charged with an 11% interest rate on a $10,000, six-month loan, you’ll ultimately pay your lender: 10,000 x .011 x 0.5. An additional $550 in simple interest over the life of your loan.
The Annual Percentage Rate (APR) of a loan gives you a more comprehensive look at how much you’ll pay when you borrow money—it’s the true, annual cost of your loan, expressed as a percentage. That’s because, unlike the simple interest rate, APR includes the cost of interest plus additional fees attached to your loan.
When you’re shopping around for loans, you can use their APRs, rather than their interest rates, to determine which truly costs less on an annual basis. But that number may be deceiving, since APRs also vary depending on the length of the loan.
For example, even if an 18-month loan and a 10-year loan have the same interest rates and fees, they will have very different APRs. That’s because the 10-year loan spreads out the fee repayment period over a much longer timeframe, lowering its APR substantially compared to the 18-month loan. However, you’ll end up paying more total money in interest on a 10-year loan than an 18-month loan.
So, when comparing APRs, be sure you’re comparing loans with the same term lengths for the most accurate representation of their relative costs.
→TL;DR (Too Long; Didn’t Read): Simple interest is the amount of interest you’ll pay for your loan, excluding additional fees. APR represents the total, annual cost of your loan, including your interest rate and any additional fees you’ll need to pay for your loan. Both are expressed as a percentage of the loan’s principal amount.
All told, the simple interest rate is not a true measure of the cost of borrowing money—that’s what APR is for. Either way, every business is its own animal. Every borrower’s interest rate, and the fees that lenders roll into APRs, will vary quite a bit depending on your business’s credentials, the lender you’re working with, the type of loan you’re going for, and the length of your loan.
Here are a few major factors that help lenders determine your loan’s interest rate, and some common fees that lenders may incorporate into your APR:
As you navigate the world of small-business lending, keep this phrase top of mind: Lenders are looking to mitigate risk. Basically, lenders need to feel confident that they’re going to get all their money back (plus interest) every time they offer a loan.
The businesses whom lenders deem lower-risk will typically receive lower interest rates, because lenders are confident that these viable companies won’t default before their total debt comes due. On the flip side, lenders charge higher-risk businesses higher interest rates, because they need to make sure that they’ll receive their money even if that business defaults on their loan.
Lots of these factors that impact your interest rate (which you’ll provide on your business loan application) will also clue you into how your lender sees you on the spectrum of risk:
1. Personal credit score. Your personal credit score is a numerical measure of your historical reliability with your financial obligations—so it makes sense that most lenders weigh this heavily when calculating your loan’s terms. Some lenders look at your business credit score, too.
2. Industry. Some lenders view businesses in certain industries riskier than others—and therefore more likely to lose revenue, or close their doors before the loan is due. For that reason, lenders may hike up interest rates on loans they extend to businesses in risky industries (if they choose to work with those businesses at all).
3. Time in business. The way your lender sees it, the longer a business has been open, the more stable they are, and the more likely they are to generate the revenue they need to repay their loan. By contrast, younger businesses are less financially stable, so lenders charge higher interest rates for an additional safety net.
4. Annual revenue and profitability. These stats are pretty straightforward: The businesses that yield higher annual revenue, and generate more profit, are more likely to repay their loan in full and on time. So, lenders charge profitable businesses less interest on their loans (or more, if the opposite is true).
5. Existing debt. Lenders favor businesses with fewer existing debt obligations on their books, because those businesses have more room in their budget to repay a new loan. As a result, they’ll charge those businesses less in interest, because they’re not so concerned about losing money.
6. Your lender. On the whole, bank loans and SBA loans charge the lowest interest rates on the market, because these lenders pretty much only work with the borrowers whom they’re absolutely certain will repay their loans (aka the lowest-risk borrowers). On the other hand, online or alternative lenders tend to charge higher interest rates, since they aim to serve a much wider range of borrowers—even (or especially) the borrowers whom the banks turned down. That’s why alternative lending was born in the first place! See how low SBA loan rates are with an SBA loan calculator.
Inevitably, all the factors that help lenders determine your interest rate will also impact your APR, since your interest rate is included in your APR. But, as we’ve pointed out, your APR also includes additional fees that your interest rate doesn’t account for.
Some of those fees could include:
Different lenders charge different fees, so you’ll have to ask your lender directly about which extra charges are incorporated into the APR. For the most part, those additional loan fees are one-time or upfront costs. Individually, they’re all expressed as a percentage of a loan.
→TL;DR: Lenders use the data in your business loan application to determine your level of risk. Generally, lenders charge high-risk businesses higher interest rates, and low-risk businesses lower interest rates. APRs account for the various, additional fees attached to your loan. Those fees depend upon your lender’s terms.
When anticipating your loan’s interest rate and APR, the biggest factors to bear in mind are your company’s financial health, as well as the length of your loan’s repayment period.
If you’re in good financial shape with minimal debt, you can expect a lower interest rate. And if you’re going with a 25-year SBA 504/CDC loan over an 18-month short-term loan, for instance, your APR is going to be significantly lower, since you’ll have more time to pay the bank fees that come with your loan.
Then, you can make a couple of hard-and-fast calculations to come up with your loan’s simple interest rate vs. APR.
Just as a reminder, here’s the formula for determining your loan’s simple interest rate:
Simple interest = Principal x Interest Rate x Duration of Loan (Years)
To determine your APR, you’ll need to know your loan’s interest rate, the amount you plan to borrow, your repayment term, and your total fees, then you can use our APR vs. Interest Rate Calculator to get a ballpark figure of what you’ll owe.
When you’re looking into small business loans, you’re going to see a lot of numbers thrown around, but your loan’s simple interest rate and APR rate are two of the most important numbers to consider.
Although the simple interest rate vs. APR seem similar—not least because they’re both represented as percentages of the principal amount—there’s a fundamental difference between the two:
Simple interest rates and APRs are vital numbers to bear in mind, because they’ll help you figure out whether you can truly afford the cost of the loans you’re shopping for. In particular, you can use APRs to compare prices between loans of the same length.
But simple interest rates and APRs are far from the only factors you should consider before making a decision on how to finance your business. For starters, you should consider the loan’s type, term, repayment schedule, the ease of obtaining your loan, and if you’ll incur a missed payment or prepayment penalty. As important as your interest rate and APR may be, keep an eye on the bigger picture to find a loan that’ll truly help your business grow.
Meredith Turits is a contributing writer for Fundera.
Meredith has worked as a writer and editor for more than a decade. Drawing on her background in small business and startups, she writes on lending, business finance, and entrepreneurship for Fundera. Her writing has also appeared in the New Republic, BBC, Time Inc, The Paris Review Daily, JPMorgan Chase, and more.