Applying for a business loan might seem daunting, especially if you’ve just started doing your research.
It doesn’t help that lending companies in the Philippines use different terms to describe their business loans. Some even require complicated math before you arrive at your final loan price. So if you’re not careful, you may end up paying more than you initially intended, or a larger monthly payment than you can handle.
A good point of comparison for all business loans and SME loans is interest rate. This is the amount that loan companies charge in exchange for giving you immediate access to funds. The general rules when comparing interest rates are:
- Lower interest rates are better. This means you are paying less for the loan.
- The higher the risk of non-repayment, the higher the interest rate. This usually means you'll pay more interest for higher sums of money or longer payment terms.
- Longer loan terms mean lower monthly payments. This matters if your business can’t handle large expenses every month.
Beyond interest rate, there are other factors that will affect the total price of your business loan. To help you make an informed decision, here are the most common terms used by lenders, and what they could mean for your interest rate.
Term loan vs. credit line
Most lenders offer two kinds of business loans: term loans and credit lines.
Term loans are a type of loan that provides you a one-time lump sum. The loan is then partially repaid every month within a specific time period. The duration will depend on your agreement with the lender – anywhere between 1 month to 30 years.
Credit lines, meanwhile, are a more flexible kind of loan. It grants you a fixed amount, called a credit limit, that you can borrow from any time. When you repay the debt (plus interest and fees) on your next billing cycle, you can borrow up to your credit limit again without having to re-apply. For this reason, credit loans are best for growing SMEs with fluctuating operational expenses and consistently-urgent financial needs.
With credit loans, you need to pay the full balance and interest on your credit line every billing cycle. Depending on your business's financial records, credit loans can have higher interest rates than a term loan.
The upside is you get to use your credit limit any time as long as your account is active. And with certain funding products, like First Circle’s Revolving Credit Line, there are benefits to being a good borrower. Your credit limit can increase, or your interest rate can get lower over time – meaning your loan cost may actually be cheaper in the long run.
Aside from interest rate, fees are an important consideration before signing a contract with any loan provider. Your best option is a loan provider that charges reasonable fees, while ensuring you know exactly what you're paying for.
- Origination fee. Often paid upfront, this is the lending company’s fee for processing your loan application.
- Underwriting fee. The lending company’s fee for taking on risk. This fee is based on a risk of loss and is sometimes included as part of the origination fee.
- Early repayment fee. Sometimes called a pre-termination fee. Some lenders charge this when you fully pay your loan before the end of your loan term. The fee changes per lender, but it is typically around 2% to 8% of your balance.
- Subscription fee. For revolving credit lines, this one-time fee lets you withdraw from your credit line multiple times within your loan term. If your business often needs funds, ask your lender if you can pay this instead of a withdrawal fee.
- Withdrawal fee. For revolving credit lines, this fee is charged every time you use your credit line. If your business doesn’t need funds often, this is a better option than a subscription fee.
- Late payment fee. It’s crucial to make your payments on time, so you don’t incur a late payment fee. Some lenders charge a high fee to discourage borrowers from defaulting on their loan.
Fixed interest rate vs. variable interest rate
Fixed interest rate means that the amount of interest rate you pay within the duration of the loan remains the same.
A variable rate, sometimes referred to as a floating interest rate or adjustable rate, means the interest can increase or decrease over time depending on the market benchmark. The market benchmark is tied to the overnight borrowing rate set by the Bangko Sentral ng Pilipinas (BSP), so it may rise and fall depending on the economy’s performance. Variable rates apply mostly to long-term loans that need years to repay; some offer a fixed interest rate for the first few years before changing your interest rate.
Consider a variable interest rate only if you are borrowing for a short amount of time. With a variable rate, longer loan durations mean that your interest rate may rise every month or year – leaving you at a higher risk of paying more than you initially planned.
A loan tenor is the length of time a business has to repay the loan amount and interest. A typical loan tenor starts at five years and can last up to 20 years, depending on the amount and the conditions of the lending institution. Keep in mind that a longer tenor means higher interest.
Use a loan calculator for the best results
To get an idea of how much you’ll have to pay yearly for a certain loan amount, you can use Forbes’ business loan calculator. Note that you'll have to replace the dollar sign with peso signs before computing:
You’ll need to know 3 things before using the calculator: your loan amount, interest rate, and term in months. Take note that the final amount will still depend on the lender, but it’s a good starting point to help you get an estimate.
Getting a business loan is a big step, but understanding all these terms will help you ask the right questions and make an informed decision that helps your business grow.
Need business funding? Explore financing options offered by First Circle, such as the Revolving Credit Line. New applicants can get up to P5 million in funding for as low as 1.39 percent.