Understanding the total cost of credit is critical to making sure you get the best deal on business finance. It's amazing (but perhaps not surprising) how many finance providers aren't transparent or honest about the full cost of credit. We're determined to educate on this issue, so we've compiled a short list of tricks you should watch out for. We've also added some tips you can use to uncover the true cost of borrowing, to make sure you're getting the best deal for your business. You could also use this free APR calculator tool to help you compare the cost of commercial finance.
Trick 1: Focus on just one 'headline' component e.g. the interest rate
Invoice finance providers are perhaps one of the worst offenders here. Businesses are attracted by low interest rates (regularly called discount charge/rate) - often quoted as a variable rate like base + 3%. This focus detracts from other components of the cost, particularly the fees. If the rate sounds too good to be true, it probably is.
Top tip: Always ask a potential credit provider what fees they charge. If you don't get a straight and simply answer, walk away.
Trick 2: Fees, fees, fees
Any fees your business is charged for your credit are adding to the total cost of the finance provided. This sounds obvious, but prospective customers comparing costs often forget to include fees when calculating cost of credit. For many commercial finance products, the fees actually represent the vast majority of the cost! If you ever thought banks weren't innovative, take a look at the variety of ways (and names) that they've come up with to charge you fees.
Top tip: Make sure you check the terms and conditions carefully for additional fees. It's often better that the total cost is determined by your borrowing (i.e. based on interest) rather than the bank (i.e. based on fees)
Trick 3: Express the cost of credit in a way that makes it hard to compare the true cost
"With interest rates from just 0.05% per day you could borrow £100,000 for just £50 a day" sounds enticing, but assuming no compounding (i.e. best scenario), that's over £18,000 per year in interest - an annual rate of 18%. On a compounded basis it's even higher at 20%.
Top tip: Watch out for any provider that presents the cost of credit without reference to an annual interest rate, and particularly without a time dimension - it's a warning sign that usually means you're being charged a lot more than you think.
Trick 4: Offer a big limit which in reality is hard to access
"Your credit limit is £100,000" is pretty clear. But are there strings attached? You will often find that your limit is only accessible by meeting several conditions which in reality mean the full amount is out of reach. That combined with a fee based on the size of the limit, means you may end up paying for credit you can't (and won't) use.
Top tip: A good question to ask a provider is "Can I borrow the full amount on Day 1?"
Trick 5: Not getting a full refund for credit you don't use
What's worse than charging you a lot for the credit you use? Charging you for what you don't use! Providers do this in lots of ways, for example:
- Charging you even if you don't borrow (non-utilisation fees)
- Charging you up front for credit assuming an amount and duration, and not providing a rebate if you pack back early.
- Charging early repayment fees
- Charging fees on monthly repayments
- Using monthly calculations rather than calculating interest on a daily basis
Top tip: Check a provider's early repayment policy by enquiring "How do you calculate early repayments?"