How Understanding APR Can Help You Prevent Credit Card Debt
If you are like millions of small business credit card holders, you have probably seen the phrase “annual percentage rate” or “APR” on your monthly statement, but you may not truly understand what an APR is, or know how it is calculated.
It may be difficult to understand, but knowing what APR is can help you make more informed credit card decisions.
At its most basic, APR is the yearly rate of interest on your credit card debt.
Depending on your agreement, your rate may be variable, and change with market fluctuations, or it may be non-variable. Should you consider one or more credit card offers, the APR is a quick and easy way to compare them.
Marc Prosser Author at Forbes recently wrote in an article that “When small businesses find out what the “APRs” are on the loans, they are much less likely to move forward with the transaction” So, why do people avoid this topic? According to a survey by the National Foundation for Consumer Counseling. Americans do not like to talk about resolving their credit card debt.
In the survey, 42.4 percent of Americans reported having credit card debt, and the average balance is a staggering $10,902. According to the survey, 37 percent of Americans would be more embarrassed to admit the balance on their credit cards than their age or weight.
The Importance Of The Factor Rate
According to many of the leading alternative lenders, all of them have claimed that APR is not a good measure of a credit card debt or loan. The argument about APR not being a good measure comes from two different perspectives:
If You Borrow For Less Time You Might Save Money
The lenders are primarily loaning money for working capital. A healthy, profitable company does not generally need infusions of working capital for long periods of time. They need money during seasonal slow periods or to prepare for a busy period and that is when they go into credit card debt. Or, a company may need to bridge the gap between doing work on a major project, and getting paid for the work.
These companies may need additional working capital for a few months, but not one or two years. The alternative lenders argue that a high interest rate loan for a shorter period of time that matches the time period when a company actually needs the money, this is actually cheaper than a longer-term loan with a lower interest rate. To put it another way, a lower rate may not actually save the borrower money if they are forced to take a loan for a longer period of time.
There Is A Big Time Cost To Getting A Low Loan Rate
In an interview, the CEO of one of the major small business loan companies kept referring to the credit card debt and loans that his company offered as convenience capital. In the case of business loans, the median size being fairly small, well under $40,000, the cost of the interest in dollar terms is also relatively small. The CEO went on to say that many of his borrowers had the credit quality to get a loan from a bank at a much lower rate, but preferred to do business through his firm. Why? The borrower could get a loan from his firm in minutes, while taking out a bank loan might take days of effort. Basically, he is arguing that just looking at interest rates as the cost of the loan was misleading, because it essentially ignored the value of the borrower’s time.
Those are the two arguments that I frequently hear from small business who are in credit card debt about why APR is a misleading indicator of the cost of a loan from an alternative lender. It can be said that there are some merit to both arguments.
APRs, Borrowers Should Easily Be Able To Compare Different Products
The cost of borrowing money is almost always represented as an APR. When a person has credit card debt, a car loan, or takes a mortgage out, the cost of the loan is represented as APR. Based on all these experiences, in the case of small business owners, they have a sense of what constitutes a reasonable or expensive interest rate.
Making It Public
For some reason, alternative lenders don’t want small business owners to use their past experiences to judge the cost of a small business loan. I can imagine an alternative lender arguing that you cannot compare a mortgage, which is collateralized by real estate, or a car loan which is secured by a vehicle, to an unsecured business loan. These secured or collateralized personal loans are much less risky for the lender than a working capital business loan, which is generally not secured by specific assets.
This argument falls apart when credit cards are brought into the picture. Most credit card debts are not secured, which makes them a good comparison for the cost of a small business loan. Using APRs, small business owners can get a sense of the cost of a small business loan.
APRs are an important tool for comparing different financial products that might have different payment structures that make comparing costs difficult. Let us say a borrower is trying to choose between two one year financing products. One has a factor rate of 1.30, and the other 1.35. However, the one with the lower factor rate has daily repayment requirements, while the one with the higher factor rate has monthly repayment requirements. Based on this information alone, it is hard to figure out which is the better deal. The one with the higher factor rate may in fact be cheaper when comparing the APRs.
When Borrowers Find Out The APRs They Sometimes Decide Not To Take A Loan
Unfortunately, it is easy to think the factor rate converts into APR. While in theory a factor rate of 1.3 can convert into an APR of 30%, generally speaking the APR is going to be much higher than the factor rate. Confusing the factor rate and APR is easy to do.
There are reports of people that talk to potential small business borrowers on a regular basis. When they share that the financing option the small business would qualify for would carry an APR of “60%”, the most common response is “I would never do that.” While a 30% interest rate sounds within reason to many small business owners, 60% doesn’t. Business owners know the return on what they use the money for has to be over 60%, in order for taking the loan to be a good decision.
The bottom line is that knowing how the APR works can make a huge difference between saving a lot of money or being in debt for a lot of money, next time you go over a contract remember to check for some very important things like for example how often are you suppose to be paying your APR since we now know how important the time factor can be.