Business Borrowing Basics

Business Borrowing Basics

1.    What does “APR” refer to on a loan, and how is it calculated?

This stands for Annual Percentage Rate. The APR formula converts the quoted interest rate to a true effective rate as well  as adding in all hid­d­en interest, such as points and­ finance charges. Your loan comes with an APR statement. Learn to readit.


2.    What does “simple interest”mean?

Simple interest means multiplying the amount of the loan by the interest rate for the period and having the interest paid at the end of each month or year in a lump sum. For example, you borrow $1,000 at10%interestforoneyear,andpaybacktheprincipalof$1,000and


interest of $100 at the end of the year, for a total of $1,100.


3.    What is the most important element of a loan, the down payment, monthly payment or totalpayments?

The total payments; these are what eat into your lifetime wealth. Longer-term loans have attractive lower monthly payments, but the lawofd­iminishingreturnsraisesthetotalcostfarbeyond­thebenefit oflowerpayments.Whenyouborrowmoney,addinallthecostsover the term of the loan to determine which has the lowestpayments.


4.    What is the “rule of 78” in a loan?

In most installment loans you are allowed to pay the loan off prior to itsmaturity.Sincetheinterestisnormallyprepaid,theloanagreement provides for a refund of interest based on the rule of 78. The 78 is derived by adding the numbers 1 through 12, and is used tocalculate the portion of the total interest charges the lender receives when you pay off your loanearly.

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