What a business loan really costs: rates, fees and the total you repay

Business lenders don't all describe their prices the same way. One quotes an interest rate, another a flat rate, a third a monthly rate or a fixed fee. Some add an arrangement fee, some don't, and the early repayment terms vary widely. Laid side by side, the offers can be hard to compare.

The fix is simple: turn every offer into pounds. This guide shows you how, and explains the pieces that make up the price.

The one number that matters

Ask every lender for the total amount repayable: every pound you'll pay over the life of the loan, assuming you make each payment on time. Then add any fees paid separately, such as an arrangement fee taken at the start.

Take away the amount you borrowed and what's left is the cost of credit: the full price of the loan in pounds.

Compare offers for the same amount over the same term on that number and most of the confusion disappears. If the terms differ, look at the cost per month or use the APR, covered below.

How interest rates are quoted

You'll come across several ways of describing the same thing.

• Interest rate (reducing balance). Interest is charged on what you still owe, so as you repay, the interest falls. This is how most bank term loans work. Our guide to how business loans work shows the repayments month by month.
• Flat rate. Interest is worked out on the original amount for the whole term, even though you're paying it down. The number looks low, but you pay interest on money you've already repaid.
• Monthly rate. Some short-term lenders quote a rate per month. Multiply by 12 for a rough annual figure, but it's still only a rough guide.
• Factor rate. Used for merchant cash advances and some short-term finance. You repay a fixed multiple of the amount advanced, such as 1.2 times. See how a merchant cash advance works.
• APR (annual percentage rate). A standard measure, calculated the same way by every lender, that combines the interest and compulsory fees into one yearly rate. It's the fairest single figure for comparing loans of different shapes.

For lending regulated by the Financial Conduct Authority (FCA), which includes loans of £25,000 or less to sole traders and small partnerships, lenders must show you the APR. Most lending to limited companies and LLPs is unregulated, and many of those lenders don't quote an APR. You can still ask for one, and you can always ask for the total repayable.

Why a flat rate looks cheaper than it is

This is the trap that catches most people, so it's worth seeing in numbers.

An illustration, not a quote. Say you borrow £20,000 over two years at a flat rate of 8% a year, with a £400 arrangement fee paid when the loan starts.

The interest is 8% of £20,000 for each of the two years: £1,600 a year, or £3,200 in total. You repay £23,200 in 24 monthly payments of about £966.67. Add the £400 fee and you pay £23,600 in all, so the loan costs you £3,600.

But you don't owe £20,000 for two years. By halfway you've repaid nearly half of it, yet you're still paying interest as if you owed the lot. Expressed the usual way, on the reducing balance, that 8% flat rate works out at an interest rate of nearly 15% a year. Include the fee and the APR is about 18%.

For comparison, a loan of £20,000 over two years at an interest rate of 8% a year on the reducing balance, with no fee, would cost about £1,700 in interest.

As a rough rule, on a loan repaid in equal monthly instalments, the equivalent reducing-balance rate is about 1.7 to 1.9 times the flat rate. So when you see a flat rate, ask for the APR or the total repayable before you compare it with anything else.

Fees to look out for

Interest is only part of the price. These are the fees that most often add to it.

• Arrangement fee. Charged for setting up the loan, often as a percentage of the amount borrowed. It may be paid up front, taken from the money you receive or added to the loan. If it's taken from the loan, you get less cash than the amount you're paying interest on. If it's added to the loan, you pay interest on the fee too.
• Broker fee. Some brokers are paid only by the lender, through a commission that can be built into your price. Others charge you a fee, often a percentage of the loan, usually payable when the loan completes. Some do both. Ask how your broker is paid and get any fee you'll owe in writing before you go ahead. Be wary of anyone asking for money before you have an offer.
• Valuation and legal fees. For secured loans, you'll usually pay for the valuation of the property or asset and the legal work, often including the lender's legal costs as well as your own. Our guide to secured vs unsecured business loans explains what's involved.
• Fees on facilities. Overdrafts and revolving credit often have an arrangement or renewal fee, and some charge a fee on the part of the limit you don't use.
• Late payment charges and default interest. Fees for missed payments, and sometimes a higher interest rate while you're behind. They won't show in the total repayable, because that assumes you pay on time, but they're in the agreement.

Early repayment charges

If you might want to clear the loan early, from a big contract, a sale or a refinance, check the early repayment terms before you sign. They vary more than most people expect.

• Some loans let you repay early at no extra charge, and you save the interest you'd have paid on the rest of the term.
• Some charge a fee, often a percentage of the amount repaid or a set number of months' interest, sometimes reducing as the term goes on.
• Some save you little or nothing. With certain short-term loans and with merchant cash advances, the full agreed cost may be due however quickly you repay.

If your loan is regulated by the FCA, you have a legal right to repay early and a right to a reduction in the interest you would otherwise have paid. The lender may be allowed to charge a limited amount of compensation. For unregulated loans, what you pay is whatever the agreement says, so read it.

How to compare offers

Line up each offer with the same questions answered, and the cheapest one usually becomes obvious. Here are two illustrative offers for the same £20,000 over two years.

Offer B has the higher headline rate, but it's about £1,000 cheaper. These figures are illustrations, not quotes.

When comparing, check:

• The total you'll pay, including every fee, and the cost of credit in pounds.
• The APR, if the loans are of different lengths or shapes.
• Whether the rate is fixed or variable. A variable rate can rise as well as fall.
• The early repayment terms, if there's any chance you'll repay early.
• The security and guarantees each lender wants. A cheaper loan that needs a charge over your home isn't like for like with one that doesn't.
• The monthly payment against your cash flow. The cheapest loan isn't the right one if the repayments will leave you short.

What moves your price

Lenders price for risk. The more confident they are of being repaid, the less they charge. These are the things that usually make the biggest difference.

• Trading history and profitability. Several years of steady, profitable trading usually earns a better price than a young or loss-making business.
• Credit history. Missed payments, county court judgments (CCJs) and a lot of recent borrowing all push the price up, on both the business's and the directors' credit files. Our guide to business credit scores explains what lenders see.
• Security. A loan secured on property or equipment is usually cheaper than an unsecured one, because the lender has something to fall back on.
• Bank statements. Healthy balances, regular income and few returned payments tell a lender you'll manage the repayments.
• Term and amount. A longer term usually means lower monthly payments but more interest in total. Very small or very short loans can carry a higher rate, because the lender's set-up costs are spread over less.
• Wider interest rates. When the Bank of England base rate moves, lenders' own costs move, and new loan prices tend to follow. Existing variable-rate loans change too.

Some of these you can improve before you apply: tidy your credit files, avoid unplanned overdraft use for a few months and have your documents ready.

Common mistakes to avoid

• Comparing a flat rate with an APR. They measure different things. Convert both to a total repayable or an APR first.
• Ignoring fees taken from the loan. If a £400 fee is deducted, you receive less than you borrow but pay interest on the full amount.
• Choosing the lowest monthly payment. A longer term lowers each payment but usually raises the total cost.
• Assuming you can repay early for free. Check before you sign, especially if you expect a lump sum during the term.
• Not asking how the broker is paid. It's a reasonable question, and a good broker will answer it plainly.

Questions people ask

What is a flat rate on a business loan?

A flat rate charges interest on the original amount borrowed for the whole term, even as you repay it. Because you're paying interest on money you've already paid back, a flat rate makes a loan look cheaper than it is. On a loan repaid in equal monthly instalments, the equivalent reducing-balance rate is usually about 1.7 to 1.9 times the flat rate.

What's the difference between APR and the interest rate?

The interest rate covers interest only. The APR combines the interest with compulsory fees, such as an arrangement fee, into one yearly figure, calculated the same way by every lender. That makes the APR better for comparing loans with different fees.

Do business lenders have to quote an APR?

For FCA-regulated lending, such as loans of £25,000 or less to sole traders and small partnerships, yes. Most lending to limited companies is unregulated and lenders often don't quote one. You can still ask for the APR and the total amount repayable.

Can I pay off a business loan early?

Usually, but check the agreement for early repayment charges. Some loans let you repay early for free, some charge a fee, and with some short-term products the full agreed cost is due whenever you repay. Regulated loans come with a legal right to repay early.

Are arrangement fees normal on business loans?

Yes, many business loans have one, often a percentage of the amount borrowed. Check whether it's paid up front, taken from the loan or added to it, and include it when you compare offers.