August 17, 2021
How to Calculate the Cost of Your Business Loan
So, how do you calculate the true cost of your business loan? The good news is, this isn’t an unanswerable question; there are plenty of useful business loan calculators that can help you determine your payment schedule, total loan cost, and more.
That said, it’s still important to learn the fundamentals of calculating a business loan’s cost. While calculators can give you numbers, you still need to understand how to use those numbers to make good business financing decisions.
In this post, we’ll explain what goes into calculating your business loan’s cost. We’ll also demonstrate how to determine your payment schedule and the impact of fees on your loan cost.
Calculating the Total Cost of Your Business Loan
To keep things simple, we’ll assume you’re obtaining a fixed-rate business loan. We’ll touch on variable rates and interest-only periods later. With a fixed-rate loan, to calculate your loan cost, you need the following inputs:- Loan principal, or the total amount of your debt.
- Interest rate
- Fees and/or discounts
- Loan term
- Prepayment penalties (if applicable)
Calculating the Cost of Variable-rate Loans
Calculating the cost of variable-rate loans requires additional steps. With a variable interest rate, the business loan’s interest rate is based on an underlying benchmark rate that changes periodically. Due to this, you won't fully know much a variable-rate loan will cost until it reaches full maturity. To approximate the total cost of a variable-rate loan, you can calculate your cost based on multiple scenarios. For example, it’s entirely possible that your rate never changes. In that case, you could use the same method for calculating the cost explained in the previous section. However, let’s say you also want to project your loan cost if your rate changes at the end of the third year of your loan. To do that, you’d need to take an extra step, which we'll detail below: Let's say that you have a five-year, variable-rate loan of $100,000 with an interest rate of 10 percent. To calculate the cost of the loan if the rate increases by 2 percent at the end of year three, you’d again use a calculator. Except this time, you’re going to do two calculations: In the first, you’ll enter the details of your loan:- Loan term: five years
- Interest rate: 10 percent
- Loan principal: $100,000
- Loan term: two years
- Interest rate: 12 percent
- Loan principal: $44,303
- Enter your original loan details into a calculator.
- Use the amortization table to look up your loan balance and total interest cost in the period in which your original rate changes.
- Enter your remaining loan balance, interest rate, and remaining term into a calculator.
- Repeat as necessary
Factoring Prepayment Fees into Your Payment Schedule
In the previous section, we touched on a very important concept: amortization schedules. A loan amortization schedule shows you the following over the life of the loan:- The reduction of your debt
- Your breakdown of interest and principal paid
- Your loan balance