If you apply for a business loan through a lending marketplace, you may receive multiple offers. So now that you’re in this enviable situation, how can you compare the loans to figure out which one is the best for your business?
The 3 Key Factors to Consider When Comparing Business Loans
Comparing business loan offers can be confusing, especially if you’re not comparing apples to apples. Say you have offers for a business line of credit and an ACH loan. How do you know which one will be right for your business? To decide which business loan best fits your needs, you should consider 3 essential factors associated with each loan offer: the cost of capital, the speed of capital, and the amount of capital.
OK, so what the heck does each of those terms mean and how can you compare them? Let’s dig in.
1. Cost of Capital
The cost of capital refers to the overall cost of the loan. Say you have a business loan with a principal amount of $10,000 and the interest/fees over the life of the loan total $3,500. The total cost of capital for that loan is $13,500. When you’re comparing loan offers, the cost of capital will help you determine how much that working capital will cost your small business on the whole.
The loan principal is the sum you are borrowing that will have to be repaid. It serves as the base for your total cost of capital.
Some small business loan types, like startup loans and equipment financing, come with traditional interest rates or APR. If you have a loan for $100,000 with an APR of 10%, then the cost of capital over a 12-month period for that loan will be $110,000.
Other loans, like merchant cash advances or short term loans, use a factor rate. Factor rates are expressed in decimal points instead of percentage points. They can often seem intimidating, but they’re not that complicated once we demystify how they work. If you have a factor rate of 1.2, it means the borrowing rate of the loan is 120%. So if you have a $100,000 loan with a factor rate of 1.2 for a 12-month term, then your cost of capital would be $120,000.
Origination fees are up-front costs the lender charges to cover the cost of servicing a loan over its life. Origination fees are often expressed as a percentage of the loan principal, but some may be charged as a flat rate.
Some lenders may charge you a fee simply for applying for a loan. You may want to ask about application fees before applying and factor that into the total cost of capital. (For what it’s worth, we never charge application fees. It’s not our style.)
We’ve run through the major components you need to consider when calculating the total cost of capital for different loan offers. If you’re ready for your 200-level course in “loan fees,” then you can check out our beginner’s guide to small business loan fees to learn everything you need to know about late fees, monthly fees, and anything else you might encounter.
2. The Speed of Capital
The speed of capital refers to how quickly you can receive funds. With some loan products, the time until funding will be relatively similar, so this may not be a deciding factor. For others, you may see a larger gap. Consider comparing a merchant cash advance to an SBA loan. The SBA loan will probably have lower rates (these government loans have some of the best rates in the biz), but given the added paperwork, the funding process is slower. An SBA loan generally takes a month or more to fund, whereas a merchant cash advance can be funded as little as 24 hours after approval. When you’re weighing your options, you’ll want to ask, “How much does time-until-funding matter to my business?” and then weigh the speed of capital for different offers accordingly.
3. The Amount of Capital
The amount of capital refers to the size of the loan, which is the most straightforward of the 3 considerations. If you’re financing a renovation and the amount of capital is paramount, then a $150,000 loan will be more obviously appealing than a $10,000 loan (which probably won’t take your renovation very far).
Make The Right Choice By Prioritizing What Your Business Needs Most
Now that you know the 3 primary factors to consider when weighing offers, how do you do it? First, you have to decide what’s most important for your business. It may be helpful to rank your needs. If one loan has a higher cost of capital, but it’s much faster, that’s going to help you when time is of the essence. If the total amount is your No. 1 priority, then maybe you’re willing to give a little on the cost and/or the speed. If you say “Nope, the cost of capital must be kept low no matter what,” you may be willing to wait longer and/or accept an offer for a smaller amount.
Knowing how to weigh your options means that when the time comes, you’ll be able to make the best, most informed choice for your business— whatever you choose to prioritize.