Anyone who has spent any time in the loan industry knows how perilous it can be for small business owners. Due to the complicated nature of loans and legal speak, brokers and lenders often try to take advantage of small business owners.

That’s why we have written this article, to explain three ways brokers and lenders try to deceive small businesses, so you and your business are not another casualty of the lending industry.

1. Don’t confuse factor rate and annual percentage rate (APR)

Passing the factor rate off as APR is a classic broker/lender scheme.

Let’s say you take out a $100,000 loan with a 10% APR. The first month, you might pay $12,000, around $11,167 of principal and $833 of interest. For month two, you still pay $12,000, but you are only paying interest on $88,833, or $740.

As you keep paying down your principal, you will be paying less and less on interest and more and more on principal. Using these numbers, you would pay off your $100,000 loan in nine months and only be paying around $4,100 in interest.

Now, the tricky thing is that brokers and dealers often substitute a factor rate, which is very different, and try to pass it off as APR. So, they’ll say, “You can get this loan for a factor rate of only 1.1. You will have to pay back $110,000.”

So, that’s just 110%, meaning an APR of 10% right? Wrong. Although it is too complicated to go into the math in this article, for a one year loan you actually have to multiply the the factor rate number (after the decimal point ) by 24 to get a rough approximation of your true APR.

In other words, for a factor rate of 1.1, your APR is actually around 26.4%, quite a bit different than 10%. Read up on it if you’re interested in finding out the actual APRs of the major alternative lenders.

2. Beware of loans that advertise “no prepayment penalty”

A lot of brokers and lenders advertise that their loans have no prepayment penalty. In other words, you can pay off your loan early without any extra cost, effectively decreasing the amount of interest you are paying.

But, you have to make sure you read the fine-print to see how interest is calculated, because many brokers/lenders will advertise no penalty for prepayment but actually stick you with paying the same amount of interest if you held the loan for the entire time.

You want the loan to have simple interest, rather than calculated interest. Let’s go with the example above. It the loan was a simple interest loan, the borrower could pay off the loan for after one month for $100,833 ($100,000 in principal + $833 in interest).

With simple interest, the borrower pays for actual time they are borrowing the money. Not so with calculated interest; you pay interest based on borrowing the money for the full term of the loan, even if the money is paid back early. WIth the calculated interest, the amount that would be needed to pay off the loan after one month would $104,100 ($100,00 in principal + $4,100 in interest).

3. Watch out for packaging, origination, and other hidden fees

Brokers and lenders like to tack on hidden fees to your loan, which often come in the form of what are known as “origination” or “packaging” fees.

An origination fee, is basically a fee that a broker or lender charges for their “work” related to finding the borrower and doing the paperwork for the loan (also known as processing or application fee).

Origination fees are the trickiest, because they are often deducted from the principal of the loan upfront. So, if you get a $10,000 loan and have a $500 origination fee, many lenders will only give you $9,500 in actual cash, although you are still paying interest as if you had received the full $10,000. Its important to ask upfront about origination and packaging fees, so there are no surprises when you receive funds.

Really, what it comes down to is doing your research, reading the fine-print, and getting the help of a professional if necessary to make sure you are not getting ripped off when you get a small business loan. Now, you’ll at least have an idea of what to look out for and know which questions are important to ask before you sign on the dotted line.

Looking for a loan? Our small business loan finder is a great place to get started.

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Marc Prosser
Marc Prosser

Marc Prosser is the publisher and co-founder of Fit Small Business, a "how to" publication for small business owners. Prior to starting Fit Small Business, Marc Prosser served as the Chief Marketing Officer of FXCM (NYSE:FXCM). During his eleven year tenure as CMO, the company grew from under 10 people to over 500 employees located throughout the globe.