The low-down on low interest rates: Are they really the best value?

Comparing rates from several lenders with a fine-tooth comb isn’t practical for most business owners, especially when you need to account for things like fees, ongoing costs, and hidden T&Cs in the fine print. Life is busy enough as it is.

This quick guide covers all the important things you need to know to get the best rate (and the most value) for your business.

We also offer a free personalised review of rates from over 80 lenders, so if you’re short on time, jump over to our loan finder and get yours.

How do business finance interest rates work?

Loan repayments consist of two portions—principal and interest. The principal is the amount you borrow.

For example, let’s say you borrow $50,000 from a bank. You’ll pay the $50,000 back over time, and in addition, a fee (interest) in exchange for borrowing the funds.

This is how your lender makes money, and it’s also to help mitigate risk involved in lending to you. The amount of interest you pay over the course of your loan varies depending on the Reserve Bank of Australia cash rate, the risks associated with lending and the term of your facility.

Let’s explore this further.

How is my monthly interest payment calculated?

Lots of factors influence how much interest you’ll pay each month, including:

• How long you’ve been in business.
• The industry you’re in.
• The market and the stability of your sales.

There are a number of ways in which lenders communicate the interest rate:

1. Factor rate

The factor rate is expressed as a decimal. For example, 1.2 is equal to 20%. If you were to borrow $150,000 with a factor rate of 1.2, you’ll end up paying $180,000 with interest included. You can work this out by multiplying your factor rate by the total amount you’re borrowing.

The factor rate does not take your loan term into account, it simply expresses the total interest percentage over any given term.

2. Total interest percentage

This is similar to the factor rate. However, rather than being expressed as a decimal, the total interest percentage (TIP) is expressed as a percentage (%). The TIP percentage is usually expressed as a % p.a. (therefore annually) or the total interest percentage over the course of the term.

3. Annual percentage rate (APR)

There are a number of ways to calculate the APR of a loan—the simplest would be to use the payment formula on excel (PMT). The APR looks at the principal balance you owe per year, and expresses the annual interest rate charged on this amount.

This is how financial institutions communicate the rate of interest on most facilities such as mortgages, credit cards and loans.

The APR is a higher figure as it expresses the interest charged on the reducing principal balance, whereas the total interest percentage per annum expresses the interest charged on the total principal.

Here’s an example:

• You borrow $100,000 over 12 months with a monthly repayment of $9,261.06.
• If we multiply $9,261.06 by 12, we get $111,132.69.
• To work out the total interest percentage, we divide the total interest component ($11,132.69) by the total principal ($100,000). This equals 11.13% p.a. (rounded to 2 decimal places).

Can interest rates ever drop to zero?

While rare, interest rates can drop to zero or even become negative. This does not mean your loan will incur zero interest, rather it means that the central bank sets a target for the cash rate at 0%.

This means that banks are able to borrow money at a lower interest rate and pass these savings onto borrowers. However, the cost of lending still exists.

For example, banks need to pay their staff to process loan applications and cover operating overheads, while non-bank lenders need to pay back their capital provider at a premium.

Does the lowest interest rate always mean the best value?

In short, no. A low interest rate isn’t always the cheapest option. While lower rates are usually more favourable, watch out for terms and conditions associated with your loan that might  impact the total price you’ll end up paying.

For example, some finance products offer a low interest rate that looks attractive at first, but when you dig deeper you might find an expensive application fee, ongoing monthly fee, early termination fee or other conditions that could be problematic down the line. And while certain T&Cs might be okay, others might not be ideal for your situation.

Here’s an example:

Let’s say you take out a business loan with an interest rate of 4.5%. You find that this rate is low compared to the other options you’ve considered. However, this option also comes with an upfront one-off fee of $850, and an ongoing monthly fee of $10.

While the first option initially seemed more attractive, the second option is actually $766 cheaper.

Missing important details in the fine print is an easy mistake.

The great thing about speaking with a lending expert is the peace of mind that comes with knowing exactly how much you’re paying, and for what.

You can chat to a lending expert at no cost, to find the best finance solution for your needs—interest rates, fees, terms and conditions all taken into account and compared against products from 80+ lenders. This way, you can breathe easy knowing you’ve scored a genuinely great deal.