Finding the right way in the interest rate jungle

When you take out a loan, interest is the cost you pay the lender for them to lend you money and is usually the most decisive factor when it comes to choosing a lender. Below, we'll figure out what you as an entrepreneur should keep in mind to find the right thing in the interest rate jungle.

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Access to finance is a prerequisite for companies to be able to invest. And just as an entrepreneur should calculate the return on an investment, you should also keep an eye on what the exact total cost of an external financing solution will land on. In this way, you can make the most informed investment decision possible and thus give the company the right conditions to grow.

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When you as an entrepreneur take out a loan with Froda, the interest is the only cost of the loan. Unfortunately, it is far from the same for all players in the corporate loan industry. Unlike the consumer loan and credit market — where the total price of a loan is presented is clearly regulated — there is both a lack of regulation and a standard for how the price is presented when it comes to corporate credit. Therefore, it is important as an entrepreneur to have knowledge about interest rates, and how different ways of presenting it will affect the total cost of the loan, in order to be able to compare different offers and choose the most advantageous option.

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What is Interest Rate?

Interest is the cost that you pay a lender for them to lend you money. Usually the interest rate is expressed as a percentage of the loan amount, but in business loans it is also common for it to be stated as a fixed cost.

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Differences in different types of repayments

Depending on the type of amortization the loan has, the interest payments may differ on each given payment. In the case of an amortization-free loan, you pay current interest on the loan amount and the amount of each interest payment changes only if you choose to amortize the loan or if the interest rate changes (the latter only applies if the loan has a variable rate). In the case of business loans, however, the most common is that the loan either has straight amortization or that it is an annuity loan. In the case of straight amortization, you amortize a given amount at each amortization time, while the interest portion decreases as the debt decreases, and the expense of the loan also decreases over time. In the case of an annuity loan, you instead pay a given amount at each deposit during the life of the loan. In the beginning, therefore, the interest part represents a larger part of the expense of the loan, but decreases over time at the same time as the proportion of amortization increases.

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Nominal interest rate vs effective rate

The nominal interest rate indicates the interest rate at which the lender sets the loan and is what we usually refer to colloquially when we talk about interest and the interest rate stated in the contract. Instead, the effective interest rate shows what the actual cost of a loan is — as it also includes any additional fees associated with the loan and how often you pay off on the same — and is the figure to look for when comparing different offers. For consumer loans, the effective interest rate must always be stated and clearly exemplified in the marketing in accordance with the Consumer Credit Act. No such regulation exists when it comes to business loans, which is why it is often more difficult to compare different offers as it is difficult to know what the actual cost will land on. Since Froda does not charge any setup fees, invoice fees or other hidden fees, you as an entrepreneur can rest assured that the only thing that affects the effective interest rate from the nominal interest rate we present, is how often you choose to repay your loan.

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Annual rate vs monthly rate

Usually when presenting the nominal interest rate, one does it as an annual rate, that is, the percentage rate of the loan per year. This means that interest expense is based on calculating it from the underlying debt at the beginning of the year. Just as when it comes to the presentation of the effective interest rate, the annual interest rate is accepted when it comes to consumer loans, as it is also regulated in the Consumer Credit Act. However, since regulation is lacking when it comes to corporate loans, many players choose to present the interest rate as a monthly interest rate instead. However, many operators present the monthly rate incorrectly in that they divide the average monthly cost by the original loan amount, instead of dividing it by the average loan amount over the year. Something that makes the monthly rate appear to be half what it really is.

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Therefore, when taking a position on an offer with a monthly interest rate, it is important to consider whether the interest rate presented is really an accurate monthly rate, or whether it is the average monthly cost expressed as a percentage. An easy way to check this is to take the average interest cost for the first twelve months of the loan and divide that figure by the original loan amount. If the figure you get corresponds to the percentage presented as the monthly rate in the offer, it means that the actual interest rate is actually twice as high. If instead it is half that, the monthly rate presented is correct, and you can then recalculate the monthly rate to an annual rate by multiplying the interest rate of the monthly rate by twelve. This makes it easier to compare different offers and get a clearer picture of what the loan will actually cost you and your company.

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Interest on outstanding principal vs original loan amount

When talking about interest, it is accepted that interest is calculated on the outstanding capital and that interest payments decrease as the debt decreases. This applies regardless of whether the loan is amortization-free, has straight amortization or annuity. In business loans, however, operators may choose to talk about fee instead of interest linked to the loan, and that fee is constant throughout the life of the loan. However, using a fixed interest fee for each repayment means that the cost of the loan in relation to the total debt increases with each month, i.e. the percentage rate becomes higher over the life of the loan. That in itself is not a problem, but some actors choose to incorrectly present the initial interest expense, expressed as a percentage of the total loan amount, as the interest on the loan. And this is a problem because it makes the interest rate appear — similar to how some people misrepresent the monthly rate — as much lower than it really is. Therefore, if you receive an offer with a fixed fee, it is important to check that the interest cost relative to the original loan amount is not expressed as the percentage of interest on the loan and, on the other hand, to compile the total interest cost of the loan over its entire term, in order to be able to compare with offers that apply interest to the outstanding capital.