At Pursuit, one of the questions we frequently hear from small business owners is, “How does interest work on a business loan?”
This Q&A covers the most common questions we hear from business owners about how interest works. Find out how interest may change as you pay down your loan, how refinancing at a lower interest rate can improve cash flow, and more.
What is interest?
Interest is the cost of borrowing money. In business, as in your personal finances, when there are things you need but you don’t have enough money saved, then you borrow money, either through short-term loans like credit cards and lines of credit or through longer-term loans.
Lenders have expenses related to providing the funds to you and the interest collected over the life of the loan helps cover those expenses. In the case of for-profit lenders, like banks, interest also contributes to profits on the money they lend.
Is interest a one-time fee that I pay when my loan closes?
No, interest isn’t a one-time fee, it’s something that you’ll pay as long as there’s any outstanding balance on your loan. With each payment you make, you’ll pay down some of the original amount of the loan – also known as the principal – as well as a portion that goes to interest. That said, many lenders do have one-time fees that are paid when you apply for a loan, when you close or both.
How does interest work on a loan?
While lenders can determine different loan terms for every loan they approve, most loans follow basic principles. If your payment is due monthly, then in each month, interest accumulates over the number of business days in a month. Because some months will have more business days than others, the amount of interest that accumulates may vary a bit from month to month.
For example, if your original loan was $200,000, and as of today there’s currently a principal balance of $150,000 outstanding, the amount of interest charged for this month is calculated on the outstanding balance of $150,000 over the number of business days in the month (not on the original loan amount of $200,000).
Over time, even though your monthly payment amount stays the same, you’ll see that as the outstanding principal balance goes down, the interest portion of your monthly payment will decrease, too. The result is that with every payment you make, more of your payment will go toward paying down the principal and the interest owed will be a little less each month.
How often do I pay my business loan?
Your loan-repayment schedule, including the interest rate on your loan, is set up by your lender and, most commonly, payments are due once per month. Your monthly statement will show the amount credited toward principal and the amount paid towards interest.
Success story: Read about how Yvette Richardson, partner at SRW Engineering & Architecture, paid off high-interest debt that required daily payments with a Pursuit SmartLoan to give her business financial stability and power further growth.
While most lenders require monthly payments, there are lenders who collect payments weekly and even daily. Often, these lenders fall into the “predatory” category, because these repayment terms are hard for small business owners to manage. If you think you may have dealt with a predatory lender, we encourage you to contact Pursuit, as we may be able to help you.
What’s the difference between a fixed interest rate and a variable interest rate?
With fixed-rate loans, the interest rate stays the same throughout the life of the loan. With variable-rate loans, the interest rate can change and it often increases several times over the course of the loan period.
I have a business loan from Pursuit but I don’t have a schedule that shows how much interest I’ll be charged each month. Can I get one?
Pursuit doesn’t provide amortization schedules (charts showing how much of each monthly payment will go to principal and how much will go to interest over the life of the loan), primarily because the number of business days in a given month varies. For that reason, the schedule may not exactly match the interest that actually accrues.
For example, while February might have fewer business days every year simply because it’s a shorter month – and, therefore, there are fewer days over which interest will accrue – a month like August will have more business days and, thus, the interest charge for the month will be higher.
Given this, you may not know the exact amount of interest you paid in any given month until after the payment is made and you review the next month’s statement, which will show how the previous payment that you just made was allocated toward principal and interest.
How can I reduce the interest that I pay each month?
There are essentially two ways to reduce the interest that you pay each month:
- You can refinance your existing loan with a lower-interest-rate loan, as long as you don’t have to pay prepayment penalties on the original loan (otherwise, the penalties often offset the benefits of refinancing).
Many of our clients who started with Pursuit SmartLoan, for example, eventually take out an SBA 7(a), Community Advantage or Microloan to pay off the SmartLoan. These options mean that Pursuit can help you improve your business’s finances for both the short term and the long term.
Some lenders allow business owners to refinance existing SBA loans with new SBA loans, too, if the interest rate is lower and will help business owners free working capital to build their businesses.
Success story: When Glenn Read refinanced higher-interest business debt to a $100,000 SmartLoan through Pursuit, he reduced his business’s monthly payments by $7,500.
- If you make additional payments to the principal to lower that amount, you’ll likewise reduce the interest that accrues each month, simply because interest accrues on the amount of the outstanding principal. Even a one-time extra payment toward principal will result in a lasting reduction in the interest you pay from that point in time on, through the life of the loan.
How do I know if my current business loan provides the most beneficial interest rates?
The easiest way to determine if your loans are optimal for your business is to talk to Pursuit’s business advisors. We can review your loans and learn about your financial goals for your business, whether you simply want to reduce the interest rates that you’re paying so that more of each payment goes toward principal, or you want to lower your monthly payments overall.
Pursuit can help
Contact us today to learn more about how we can help.