What is the cost of a business line of credit?
A business line of credit is like a credit card: You can borrow with a maximum spending limit and only pay interest on the amount you use. It is a flexible option that can help business owners cover daily expenses.
As with any business loan, obtaining a business line of credit has costs, including interest rates and fees, that can vary from lender to lender. To better understand how much a business line of credit costs, here's a look at common rates and fees.
Business line of credit: Rate of interest
The interest rate is expressed as a percentage and represents the amount the lender will charge you for your business line of credit, excluding fees. For both secured and unsecured types of business lines of credit, rates typically range from 8% to 60% APR or higher.
Established companies with great credit and a profitable track record are considered low risk and tend to command the best rates. If you have bad credit, expect to pay more, although you may be able to reduce costs by offering guarantees.
To get an idea of how much interest you'll pay, use a business loan calculator, which can show you how much you'll pay per month and how much interest you'll pay. For example, here's a look at how much a $100,000 loan with an interest rate of 20% would cost if it took two years to pay off.
- The loan amount is $100,000
- Loan term (months) is 24 months
- Interest rate is 20.0%
- The total cost is $158,963.30
- Total interest paid is $58,963.30
APR
An annual percentage rate (APR) is a percentage that shows how much you'll pay for a business line of credit each year, including interest and fees. APR rates are more than just interest rates because they show you the full picture of what you owe.
Listick Tip
Business credit cards can come with higher interest rates than the introductory rates of business lines of credit. But a business credit card is one of the only types of financing that allows you to avoid paying interest.
Factor rates
Another technique to calculate the cost of a company line of credit is to use factor rates. Instead of percentages, factor rates use decimals. Most lenders charge a flat factor rate between 1.1 and 1.5. And just like interest rates, the lowest rates are usually reserved for well-established and successful companies with good or excellent credit scores.
To determine the total loan amount using the factor rate, multiply the loan amount by the factor rate. For example, an a total of $100,000 loan having a factor rate of 1.4 will cost you $140,000, but this does not include any costs.
How to convert factor prices to APR
When looking for a business line of credit, it is helpful to be able to get an accurate picture of your overall costs. Hence it is a good idea to convert the factor rate into the interest rate. Here's how to do it with a $100,000 loan with a factor rate of 1.4 and a two-year repayment period:
Step 1: Find the total amount due.
First, multiply the loan amount by the factor rate to get the total loan amount.
Step # 1
Principal Loan Amount x Factor Rate = Total Loan Amount
Example: $100,000 x 1.4 = $140,000
Step 2: Find the total cost of interest.
The total interest cost will be the difference between the original financing amount and the total loan amount.
Step # 2
Total Loan Amount - Principal Financing Amount = Total Interest Expense
Example: $140,000 - $100,000 = $40,000
Step 3: Convert the cost into a percentage.
Next, divide the interest cost by the original financing amount to find the percentage cost.
Step # 3
Interest cost/principal financing amount = percentage cost
Example: $40,000 / $100,000 = 0.4
Step 4: Find the annual interest rate.
Next, multiply the percentage cost by 365 to find the interest rate over one year.
Step # 4
Percentage cost x 365 days in a year = X
Example: 0.4 x 365 = 146
Then divide your answer by the recovery period.
Step 4 (continued)
X / Repayment time (in days) = Annual interest rate estimated
Example: 146/730 = 0.2 or 20%
Keep in mind that this is not the actual APR because it does not include fees. But converting the factor rate into an APR can make it easier to compare the costs of using a business line of credit with different lenders.
Steps to convert factor rate to APR Example
Step 1: Find the Total Loan Amount $100,000 x 1.4 = $140,00
Step 2: Find the Total Interest Cost 140,000 - $100,000 = $40,000
Step 3: Convert the cost into the ratio $40,000 / $100,000 = 0.4
Step 4: Find the annual interest rate 0.4 x 365 = 146.
Step 4 (continued) 146/730 = 0.20 or 20%
Approximate APR 20%
Listick Tip
Once you've converted the factor rate into an APR, use a business loan calculator to see how much a loan with a similar APR would cost. You may be surprised to find that it can be cheaper than an interest rate loan. For more information, see our guide on converting factor rates to APRs.
Business line of credit cost: Repayment terms
The amount of time it takes you to pay off the loan can also play a role. Business lines of credit cost more with interest rates the more you borrow. This is because until your loan is paid off in full, interest continues to accrue on the unpaid balance. Pay off your balance early, and you can save money.
Factor rates are usually fixed costs, which means that the amount you owe won't change regardless of when you pay it off early. For example, a loan above $100,000 with a factor rate of 1.4 will cost $40,000 whether you pay it off in two years or in one.
Longer repayment periods can make weekly or monthly payments easier. Sometimes, the lender may offer a prepayment discount, which helps you save money. But a shorter repayment period may not be in your best interest if it isn't.
Business line of credit cost: Fees
In addition to interest, business loan fees also increase the cost of a business line of credit. Depending on the lender, you may be assessed a few different fees. Here is a look at some of the more common fees you may incur:
Withdrawal fees. A fee is charged for opening your business line of credit.
Annual fee. A fee is charged each year your company's line of credit remains open.
Maintenance Fee: A fee imposed on a monthly or annual basis to maintain your company line of credit open.
Drawing Fee: A fee is charged each time you draw on your line of credit.
Prepayment fine. A fee is charged if you try to pay off the loan early. Not all lenders charge one fee, so if you plan to pay off the loan early, make sure the lender does not assess these fees.
Bottom Line
A business line of credit is ideal for businesses that want to solve short-term issues with cash flow and cover running expenses such as payroll, inventory, and supplies. But when interest and fees are factored in, the cost of borrowing can be much higher than expected.
If you're considering a business line of credit, comparing the total cost of each option can help you save money.
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