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How to Calculate Interest Rates on Small Business Loans

Interest rates on small business loans

What does your lender stand to gain when you apply for a loan? It’s the amount attached to the principal amount you borrowed. Interest rates on small business loans are the calculated figures you pay for taking out a loan. It is why your lender offers to help you out with the business loan you need. How much you end up paying overtime depends on the agreement you had before signing on the loan.

During the agreement, you will have negotiated on a specific rate with your lender. For instance, you may be required to pay an interest rate of 5% every month within three years. So, if you want to pay back and you’re unsure of how much to pay in total, this article will show you how to calculate the interest rate on your small business loan.

MUST-READ: The Ultimate Guide to Getting a Business Loan in Nigeria.

interest rates on small business loans

What Interest Rates do Business Loans Use?

Ordinarily, many business owners might be tempted to calculate their interest rates using the simple interest formula. However, this is a complete assumption many business owners make when agreeing to a loan. It might be because it’s a simple and direct calculation. 

Using simple interest, all you have to do is calculate the entire interest on the principal loan amount and payback. Take, for instance, you have to pay a 5% interest on a N10,000 loan within three years.

N10, 000 x 0.05 x 3= N1, 500

So the overall interest on this loan is N1, 500 which can be paid thrice as N500 annually.

Quite straightforward yeah? 

Well, too bad business loans don’t use simple interest rates.

Business loans, like every other commercial loan such as a mortgage, make use of the compound interest formula when calculating interest.

The Difference Between Simple and Compound Interest

Since we’ve established that your interest will be calculated using the compound interest, what exactly is compound interest?

The compound interest here means calculating the interest rate on the principal loan amount, as well as the interest that was paid during the accumulating period. To put simply, you’d be paying interest for your interest.

A great example is your bank savings account. Let’s say over time, your initial deposit of N30,000 has fetched you an interest of N240. In total, your new balance will be N30, 240. When the bank wants to calculate the interest for the next month, they wouldn’t be calculating the principal amount as N30,000 anymore but as N30,240.

Now the difference with a business loan is that you aren’t the lender. You are on the other side of the transaction as the recipient. So you are the one who’s going to pay for this loan with compounded interest.

How to Use Microsoft Excel to Calculate Interest Rates on Small Business Loans

Well, even if using the direct compound interest formula might be easy for school students, it might be time-consuming. This is why tools have been introduced to help calculate these rates. 

With Microsoft Excel, all you need to do is fill in row and columns as you let it do the calculation for you. Let’s say for example you get a N1000 loan with an interest rate of 5% that compounds every year, here’s how you calculate it

  1. On Microsoft Excel, type “Year” in cell A1 and the “Balance” in cell B1.
  2. Enter the years 0-5 from A2- A7.
  3. Since the balance for year 0 is N1, 000 enter “1000” into cell B2.
  4. In cell B3, enter “=B2*1.05”
  5. In cell B4, enter “=B3*1.05”
  6. Repeat this method till you get to cell B7 which should be “=B6*1.05”
  7. The calculated value in cell B7 would end up being N1, 276.28 which translates to the total balance after 5 years.
  8. To find the interest subtract N1, 276.28 from N1, 000 and that will sum up to N276.28

Using Online Calculators to Calculate Interest Rates on Small Business Loans 

There are many free calculators online that can be used to calculate interest rates on small business loans. These calculators are fast and highly efficient to use. A few of them include

  1. Financial-calculators.com which shows you the interest total, the future value, and the yearly percentage increase.
  2. Investor.gov a great choice for monthly interest rates. Helps calculate all the monthly additions to the principal loan amount.
  3. Thecalculatorsite.com which is perfect for calculating in different currencies and comes with many other interesting features.

Conclusion

The loan interest rates and terms will be included in the agreement form. Most times, it comes with a schedule, the amount of interest that will be garnered during the compounding period as well as the total future value to be paid back in full. 

This is why it is important to consult an expert that will put you through the entire process. Take time to thoroughly understand the terms of a loan before signing it so you don’t accrue a debt you cannot payback. This cannot be overemphasized.