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Loans 102: All About General Loan Terms and Costs

Brian ChoAuthor

This article will help you understand how common types of loans work, as well as how to evaluate the all-in costs associated with different loans to help you decide which loan option is best for your needs.

The information discussed in this article is provided for informational purposes only and should not be relied upon as financial or legal advice. For financial or legal advice, you should consult a professional financial advisor or your attorney.

Toast Capital Loans are issued by WebBank. Loans are subject to credit approval and may not be available to borrowers in certain jurisdictions. WebBank reserves the right to change or discontinue this program without notice.

Fixed fee-based loans

Recently, fixed fee-based restaurant loans have become more popular — primarily because of their simplicity and transparency. Why is a fixed-fee loan simpler than an interest-based loan? Assuming no other fees or costs are associated with the loan, a fixed-fee loan tells you exactly how much you’ll pay for the loan and the total repayment amount (your loan amount plus the fixed fee).


What is a fixed loan fee?

A fixed loan fee uses a fixed percentage, which is applied to the loan amount requested. This percentage does not change over time, so you’ll know exactly how much your loan fee is. Generally, this fixed fee is spread out and repaid over the life of the loan instead of as an upfront fee.

  • For example, a $10,000 loan amount with a 5% fixed fee results in a $500 fixed fee and a $10,500 total repayment amount.


What is a “factor rate”? Sometimes, instead of a percentage, you’ll come across what’s called a “factor rate.” Factor rates show up as a decimal multiplier (like 1.10x). They are applied to the loan amount to calculate the total repayment amount instead of the fixed fee; subtracting your loan amount from the total repayment amount will show you the fixed fee amount.

  • For example, a $10,000 loan with a 1.05x factor rate results in a $10,500 total repayment amount. Subtracting your loan amount shows that the fixed fee is $500.


Let’s take a look at the example below using simple numbers to see how the math works:


Fixed fee loan A

Fixed fee loan B

Fixed fee loan C

Loan amount

$10,000

$100,000

$300,000

Fixed fee amount

$500

$10,000

$60,000

     Fixed fee percentage

5%

10%

20%

Total repayment amount

$10,500

$110,000

$360,000

     Factor rate

1.05x

1.10x

1.20x


How is the fixed fee calculated?

So, what goes into loan fees? Each lending solution provider will have their own calculations, but fixed fees generally come down to a few primary criteria:

  • Loan amount requested: larger loan amounts naturally result in larger fixed fees — the fee scales up due to the increased funding amount and associated risk for the lender.

  • Loan length, or target repayment: longer loan terms are generally riskier for lenders and often result in a higher fixed fee percentage — conversely, shorter-term loans carry less risk and typically cost less.

  • Business information: your business history and historical/projected revenue can contribute to the lender’s understanding of your business’s stability, risk profile, and repayment estimation calculations.

  • Risk and other factors: various items, such as a large outstanding debt amount, previous business closures and bankruptcies, or issues uncovered from credit checks, can contribute to your business’s overall risk profile.

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Interest rate-based loans

Since lending money comes with risk and cost to lenders, they may charge you a percentage of your unpaid principal balance on a periodic basis until the loan is paid off (a.k.a. when their risk and cost go away). This percentage is your interest rate. 

You’re likely already familiar with how interest rate-based payments work, whether you’ve encountered them for business needs (like a bank loan or SBA loan) or personal needs (like a car loan or mortgage). 


What is an interest rate?

The interest rate is an agreed-upon, enforceable loan contract term generally expressed as an annual percentage. Interest usually accrues daily but may accrue at a different periodic rate depending on the lender (e.g., monthly). 

For example, suppose you have an annual interest rate of 5%. In that case, you can roughly calculate your daily rate for a given day by multiplying your unpaid principal balance by 5% and dividing by 365 (though many lenders use 360 days instead, depending on the terms of their credit agreements). 

As interest accrues, it is added to your total loan amount and repaid over the term of your loan until it has been repaid in full. You can effectively control the total interest you pay by altering how long it takes you to pay off your loan. Repaying your loan ahead of schedule means you’ll pay less in total interest — however, if stated in your credit agreement, you may be subject to a prepayment penalty. We’ll cover prepayment penalties and other loan costs below.


What is the difference between a fixed interest rate and a variable interest rate?

  • What is a fixed interest rate? A fixed interest rate is one consistent interest rate that applies over the life of the loan. For example, an annual interest rate of 5% will remain 5%.

  • What is a variable interest rate? A variable interest rate varies according to fluctuations in a specific, agreed-upon market index. For example, a variable interest rate could be tied to the Prime rate, or it sometimes could include a fixed component, such as the Prime rate plus some fixed percentage. 


What is capitalized interest?

Interest that is added to the principal is called “capitalized interest.” Depending on your loan terms, interest may capitalize after a certain event — for example, the end of a quarter — and all of the interest that accrued before that event will be added to the principal. 

Going forward, interest will accrue on the new principal amount (meaning that new interest accrues on old interest). This is called “compounded interest” and can end up adding a significant overall cost to your total repayment amount when all is said and done.

Other common loan fees

  • Origination Fee: an upfront fee typically based on a percentage of your principal loan amount — it’s meant to cover the costs of decisioning your application and funding your loan.

  • Late Fee: a per-occurrence fee if you are late on a payment that may be a fixed fee or a percentage based on the unpaid amount for the affected repayment period.

  • Prepayment Fee or Early Repayment Fee: a penalty for repaying your loan (typically interest rate-based loans) earlier than the term set forth in your credit agreement.

    • Why do some lenders charge prepayment fees? Lenders primarily rely on earning revenue from your interest payments over the life of the loan. By repaying early, the lender loses out on the remaining interest payments you would have made, so sometimes, they charge a fee to offset those would-be losses.

  • SBA Guarantee Fees (for SBA Loans): a fee passed through from the lender to the borrower for SBA loans

    • What is an SBA guarantee? The SBA guarantee incentivizes lenders to participate in the SBA loan program to fund small businesses. The SBA guarantees large portions of these loans, and the SBA guarantee is meant to cover the associated risks and costs.

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Repayment term

As mentioned earlier in this article, the repayment term isn’t a “cost.” However, even in cases where your interest rate or fixed fee doesn’t change during the term of your loan, the amount of time it takes you to repay your loan generally factors into the total cost of a loan.

  • For fixed-fee-based loans, as repayment terms increase, the fixed fee also increases to cover the risks of longer repayment periods. Repaying a fixed-fee loan early also has limited benefits, as the fixed fee must be repaid regardless.

  • For interest rate-based loans, you’ll pay more in interest for longer repayment periods and may end up paying more than expected if you hit any snags that slow down your repayment pacing.

For certain loan products such as fixed-fee-based loans, you may see “repayment term” referred to as a “target maturity” or “target repayment period/term”— this is the amount of time the lender expects the loan to be repaid.


What are some pros and cons of shorter vs. longer repayment terms?



Shorter terms (e.g. <1 year)

Longer terms (e.g. 5+ years)

Pros

  • More long-run flexibility: repay loans quickly and get the loan off your books, or apply for another loan (whether short or long-term)

  • Stability: your ability to repay is less likely to be negatively impacted by long-term business and economic changes.

  • Less impact: your business will “feel” the loan less since repayment is spread out over several years

  • Growth-oriented: allows your business to utilize your funds right away

  • Larger loan amounts: the longer repayment term generally offsets some of the lenders’ risks associated with offering larger loan amounts

Cons

  • More short-term business impact: more of your sales/profit will go toward repaying your loan

  • Less short-term flexibility: not much wiggle room for repayment if something unexpected comes up

  • Lower funding amounts: shorter repayment terms generally mean less funding available due to associated risks

  • Higher risk: business disruptions, economic changes, or other unexpected events could negatively impact your ability to repay on time and could result in penalties and/or debt staying on your books for longer than desired.

  • Less long-run financial flexibility: it may become difficult to get additional financing with a large, long-term loan on the books

  • Slower: generally have more involved applications and slower turnaround

Total repayment amount

Now that we’ve covered some major components of loan costs, it’s clear that loans have unique costs with variables and future unknowns that could further impact those costs. So, what’s the best way to evaluate different loan product options, especially if you’re considering a fixed-fee-based loan against an interest-rate-based loan?

Estimating your total repayment amount is a great way to compare different loans. When going through this exercise, you can focus only on sure-shot loan costs or incorporate the risks of other costs, such as late fees or prepayment penalties.

Let’s look at an example below:


Fixed fee-based loan A

Interest-based loan B

Loan amount (Principal)

$200,000

$200,000

Repayment term / Target maturity

1 year

5 years

Repayment timing

Daily

Monthly

Repayment type

Automated

Check/ACH

Application-related Fees



Application fee

None

$100

Hard credit check fee

None

$50

Primary Loan Fees



Fixed fee amount

$40,000

N/A

Interest rate

N/A

10%

Total estimated interest

N/A

$37,614

Additional Loan Fees



Origination fee

None

$4,000 (2%)

Late fee

None

N/A — assume on-time

Prepayment fee

None

N/A — assume on-time

Estimated repayment per day/month

$657.53 per day

$4,249.41 per month

Total repayment amount

$240,000

$254,965

Annual Percentage Rate (APR)

47.2%

10.9%

What is an APR?

An Annual Percentage Rate — or APR — is the estimated average annual amount that you will pay on top of the principal, including both interest and most fees, expressed as a percentage of the principal. APRs are meant to help borrowers compare loan offerings primarily by factoring in terms and costs. The APR formula is dictated by federal and state regulations so that all lenders express costs the same way.  

However, while APRs seek to equalize all loan costs and terms into an annual rate to represent the average annual cost as a percentage, they don’t do the best job of contextualizing your total loan repayment amount. 

As you can see in our example above, the APR for a shorter-term loan will be much higher than the APR for a longer-term loan. That’s because the costs are being spread out over time for the longer-term loan. Despite the different APRs, both loans have roughly the same total repayment amount. 

What’s the difference between an APR and an interest rate?

Repayment timing

The repayment structure of the loan — how often you’re expected to make payments toward the loan — is often forgotten about by borrowers. Whether repayment is daily, weekly, biweekly, or monthly, it all comes down to personal preference. 

  • A shorter repayment cadence, such as automated daily repayment, may help operators budget better because the loan repayment is already taken out of their end-of-day cash balance. They also may feel less “pain” from repayment because there isn’t anything to keep track of. The main downside of automated daily repayment compared to monthly repayment is that you’ll have less cash on hand during the month since you’re repaying every day, as opposed to making a big payment at the end of the month.

  • A longer repayment cadence, such as monthly, allows operators to keep more cash on hand through a given month up until the payment is due, increasing cash flow flexibility during the month. Some downsides include potentially missing the payment and incurring late fees and heightened importance on budgeting to make sure you can make that large payment at the end of the month. When bills all come due at the end of the month, larger and unexpected cash needs all may end up competing for the same pool of cash.


Repayment type

The way you repay a loan is a minor detail, but one that could have operational implications down the road. Repayment falls into two categories: automated and manual.

  • Automated repayments could take a couple of forms depending on the lender, but both of them take the manual work out of loan repayment, allowing you to focus on your day-to-day. One option is you could authorize automated repayments via ACH. Another option is specific to sales-based financing and merchant cash advances, where sales are withheld on a daily basis to repay the loan automatically.

  • Manual repayments require you to make payments on your own, generally through the lender’s online portal. Typically, you’ll repay via ACH, but certain lenders may allow other forms of repayment, including by credit card. While earning points by repaying with a credit card may sound alluring, there is usually a convenience fee associated with paying by card, and it also exposes you to risk of “debt spiral” because you’re effectively moving debt from one source to another, higher-cost source.

What is a “debt spiral”?

Wrap-up

Congratulations on reaching the end of our loan terms and costs course! There is much to take in between different loan types and costs. You’ve now got a better idea of how all loans are not created equally, and while APRs are one way of helping compare loan offers, APRs need to be taken with context as just one of the tools in your toolbox.

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