How to Calculate a Business Loan APR

How to Calculate a Business Loan APR

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Calculating the annual percentage rate (APR) of a given loan isn't easy. However, doing so is the best way to convert different loans side by side. APRs, while they may be far from perfect, are the most common metric used to show the cost of a loan. Unfortunately for small-business owners, APRs are a relatively rare metric among small-business loans, especially from online lenders. Instead, borrowers will receive rates in the form of simple interest rates usually. We put together a guide on how to quickly calculate APRs on your own.

How to Calculate the Annual Percentage Rate (APR)

To best explain how to calculate the APR of a loan, let's craft a sample scenario: Let's say you have Loan A, which is a $100,000 loan with a 5% interest rate and a fixed 10-year repayment plan. You also need to pay a one-time origination fee of $1,000.

We recommend utilizing either Microsoft Excel or Google Sheets for these calculations. There are built-in formulas to help easily calculate APRs, and they also reduce the risk of human error. However, we'll explain the theory and logic behind each step to help you understand exactly what goes into an APR and how to do this on your own moving forward.

Step 1: What's the Monthly Payment?

First, enter the “PMT” function into a cell. The PMT function shows the periodic payment for a given loan. You can adjust this function for daily, weekly or monthly payments.

The syntax is =PMT(rate, nper, pv, [fv], [type])

ratehere would be .05 or the 5% simple interest rate charged to the loan
nperthe number of payments for the loan until it would theoretically reach 0. If Loan A had a monthly repayment plan, it would be 10 years (total length of loan) x 12 (number of months per year) or 120. If we were to calculate weekly payments, we'd use 520 here because there are 52 weeks per year.
pvrepresents the present value of the loan, which is $101,000 in our case including the initial size of the loan plus the one-time origination fee
fvoptional syntax that represents the final value of the loan you'd like once it is paid to completion. The default value is 0.
typeoptional syntax that distinguishes between loans where payments are due at the beginning of each payment period or at the end. The default setting 0 or at the end of the period.

Your syntax should look like the following:

Calculating the Monthly Payment

You should end up with a monthly payment of $1,060.66.

Step 2: Let's Calculate the APR

Now, let's calculate the APR by using the “RATE” function. The RATE function shows the interest rate per payment period. We can adjust the function a bit to show the fixed APR for Loan A.

The syntax is =RATE(nper, pmt, pv, [fv],[type],[guess]).

nper, pv, fv, typesame as above
PMTthe monthly payment we calculated above. In our case, it's $1,060.66.
guessoptional syntax that represents whatever the user guesses what the rate is with a default value of 10%.

Your syntax should look like the following:

Calculating the APR

You may be wondering why we subtracted the $1,000 origination fee from the $100,000 loan. You might also be wondering why $1,000 fee wasn't accounted for in the monthly payment.

When a lender issues a loan, they usually issue you the loan minus any associated fees. However, your monthly payment is still based off the original amount that you loaned. So in our case, the monthly payment is still based off the $100,000 loan we originally signed up for. In reality, we would receive $99,000, since the lender would keep the $1,000 to pay for that origination fee.

When we calculate the APR like we do in step two, we need to account for the present value of the loan, which is the amount we originally decide to borrow minus the fees. In other words, those additional fees reduce the present value of our loan. This is why we account for the fees only in calculating the APR and also why we subtract the fee from the present value of the loan.

Therefore, we end up with a monthly APR of 0.43% and an annual APR of 5.22%.

What is an APR?

APR stands for annual percentage rate, and it is the most commonly used metric to display the cost of financing including business loans, credit cards and mortgages. The APR is different from other rates, in that it captures the interest rate and fees associated with the loan even if they are one-time fees.

No one claims that the APR is the perfect way to capture the true cost of financing, but it's the most commonly used metric and makes apples-to-apples comparisons possible. You don't want to be comparing two loans side by side if one uses an annual interest rate (AIR) and the other uses a factor rate. Instead, convert the two into APRs to be sure you understand the true costs of both.

You'll also want to be sure to compare your loan's APR to the rest of the market. APRs fluctuate significantly from lender to lender and from loan to loan. Eyeing an APR without any context in comparison to the rest of the market is pointless.

Other Factors to Consider

It may be tempting to simply select the cheapest option or the one with the lowest APR, but bear in mind that there are a number of factors to consider. How much financing do you need? How often can you repay your loan? These are some examples of important parameters to keep in mind when you select your optimal financing option.

Additionally, look out for lenders that provide benefits to repeating customers. If you like the service that a certain lender provides, and you'd like to continue using them, be sure to check if they offer discounts for customers that come back. One example is OnDeck, which provides small discounts for each subsequent loan.

Justin is a Sr. Research Analyst at ValuePenguin, focusing on small business lending. He was a corporate strategy associate at IBM.