Interest rates aren’t the only cost of borrowing

Applying for a loan is like planning a dream trip. After weeks of research, you find a seemingly unbeatable price on airfare, only to realize later that you’ll be hit with extra charges for baggage, seat selection and those oh-so-tempting in-flight snacks. Suddenly, your once-affordable flight has turned into a budgeting nightmare.

Before you seal the deal with a loan agreement, take a step back and consider the bigger picture of what borrowing entails. Whether it’s a business loan or a new line of credit, every financial product comes with its own set of expenses that — if not fully understood — can significantly impact your wallet in the long run.

First, review borrowing basics

Before we dive into the details of loan fees and lesser-known costs, let’s review the fundamentals of borrowing. When you take out a loan, a few key components are always in play.

• Principal — The original amount you borrow from the lender.
• Interest and interest rate — The cost of borrowing, calculated as a percentage of the loan amount that’s charged each year. Your interest rate is influenced by market conditions, the creditworthiness of the business and its owners, and the type of loan.
• Annual percentage rate (APR) — The total cost of the loan, including both the annual interest and any fees, averaged over the full term of the loan.
• Loan term — The time it will take to repay the loan if you make only the minimum monthly payments, also known as the repayment period.
• Added fees — Vary widely among lenders. Understanding additional fees will help you accurately assess the total cost of borrowing.
• Escrow — Some loan agreements or some lenders require an escrow account which are used to collect and hold funds for expenses such as property tax and insurance. Your lender may require you to make escrow payments as part of your monthly loan payment.

Factor in added expenses

It’s the lesser-known add-on expenses that have the potential to make a real dent in your finances. While they may seem insignificant at first, these fees can add up and catch you off guard. To stay one step ahead and avoid being taken by surprise, here are a few important, too-often-forgotten costs to keep in mind.

• Origination fees and application costs are upfront expenses associated with obtaining a loan. Essentially, you’re paying for the lender’s time and effort spent reviewing your loan application — just as an airline would charge to cover the expenses associated with processing your online reservation. Often included are underwriting fees, which cover the costs of assessing your creditworthiness and evaluating the lending risk and typically range from 1% to 5% of the loan amount.
• Prepayment penalties are unexpected fees imposed when you decide to pay off your loan before the agreed-upon term. They are designed to compensate the lender for any interest income lost due to early repayment. Most often associated with mortgages, prepayment penalties can significantly impact your financial plans if you intend to repay your loan ahead of schedule.
• Late payment fees and penalties are incurred when you are unable to make your loan payment by the specified due date. They are a consequence for late payments and can vary in structure. Typically, they are either a fixed amount, such as $25 to $50, or a percentage of the overdue payment. Avoid these fees by making timely payments.
• Insufficient funds fees are imposed when you don’t have enough money in your bank account to cover the loan payment. These fees occur when the lender attempts to withdraw funds but is unable to do so because the existing balance is lower than the payment amount. By maintaining the minimum payment amount in your account at all times, you can avoid incurring these charges and potential overdraft fees from your bank.
• Referral fees may be applicable when you are referred to a different lender or loan servicer, often when your loan is transferred to another company. Referral fees are intended to cover the costs associated with this transfer process. They can be either a set amount or a percentage of the loan amount, typically ranging from 0.5% to 1.0%.
• Wire transfer fees may be incurred when transferring money electronically between accounts. Some banks charge a flat rate for wire transfers, while others may impose a percentage-based fee. On average, domestic wire transfer flat fees range from $15 to $30, while international wire transfers typically cost $30 to $50.

Cracking the code

Between the fees and climbing interest rates, venturing into borrowing may feel a bit daunting at first. But with the right strategies, you can navigate with confidence, gaining the financial flexibility that borrowing allows while keeping your business finances on track.

• Carefully review loan terms. Take the time to read and understand the loan terms, including the fine print. Pay attention to any easily overlooked clauses or fees that could have an impact on the total cost of the loan.
• Compare APRs. Looking at the APRs of different loan options can give you a clearer understanding of the overall cost and help you make informed decisions.
• Consider the repayment schedule. Longer loan terms may result in lower monthly payments but could also lead to higher overall costs due to accrued interest. Determine what works best for your budget and financial goals.
• Factor in fees. Beyond the interest rate, identify all other potential charges — from initial application costs to referral fees — that may arise during the loan term. Maintaining a rainy-day fund to cover any unexpected costs can help you safeguard against accidental penalties.

The dollars and sense of it all

Remember, the purpose of borrowing is to strengthen your business finances. Before you put pen to paper, be sure to delve into the details of your loan, unravel its fee structure and grasp how it may shape your ability to repay. Stay proactive, stay informed and make borrowing choices that not only accelerate the potential of your business but also put you in a position to seize the next opportunity.

To learn more about the costs of borrowing and how credit can help you build up your business, talk with a Chase banker in your area.