When entrepreneurs are opting in for financing, they should also consider origination fees.
When a small business entrepreneur is seeking finance for his or her business, it is essential to ponder one question – “what am I attempting to achieve?”. Financing decisions don’t get made in a vacuum. The small business entrepreneurs often miss out on the essential details when evaluating whether to borrow or not, like the time drainage, full financing expense, baked-in fees, and opportunity expenses.
The correct financing choice differs for every organization. But Mark Elenowitz has observed a few areas where small business entrepreneurs’ have made financing mistakes. These can lead to several pitfalls, and it is necessary to avert them as much as possible.
- Getting aware of the actual interest rate
Often people who claim that they can calculate an interest rate can’t do the same! For instance, if you borrow $1,000 and then pay $1,100 over three months in weekly installments, the interest rate wasn’t 10%. When you take a minute look at the timeframe and the principal outstanding amount, it reveals that it’s close to 80%. It’s a difference of 70% point in the financing expense.
This error occurs as most entrepreneurs calculate the APR as total expense divided by the borrowed amount, instead of calculating the interest based on the outstanding amount at every point.
- Paying attention to hidden costs
When entrepreneurs are opting in for financing, they should also consider origination fees. Several lenders charge origination fees of 3 to 4%, which gets subtracted from the loan amount. Based on how fast you repay the loan, the expense can significantly impact the actual interest rate you’re paying.
A $30 fee on a loan amount of $1,000 is a 3% fee upfront that will skew the real APR for the short-term loans. It is similar to the ATM fees that appear to be a small amount but can cost a considerable time in the long-run. When borrowing cash, entrepreneurs should stay aware of the expenses that come with capital infusion: application fees, administrative fees, due diligence fees, and contract fees. These fees at times get hidden in print. Hence, it is essential to glance through everything before going forward.
- Look at opportunity cost as the actual cost
The banks, on routine, take two weeks to review a loan application. And when sanctioned, it takes another 15 to 60 days to fund the loan. For the entrepreneurs running a business, they can spend in generating sales and expanding the organization. The lesser APR doesn’t offer the best financial choice when you consider the time loss elsewhere. The age-old adage that is time money is right till date. It is essential to search for lenders, offline and online, that moves with new-age business speed and fastens the application process. It will help entrepreneurs spend more time generating money than spending time borrowing the same.
Other than the opportunity cost of your time, it would help if you considered the timing cost. If you aim to take extra work or purchase inventory, the bank loan timing might or might not work for you.
These are a few crucial financing mistakes that small business entrepreneurs should stay away from.