Before Taking out a Business Loan, Be Cautious of This Fee

Business.com / Funding / Last Modified: February 22, 2017

What are business loan origination fees and what type of impact does it have on your loan? Read more inside.

Taking out a business or personal loan can be great to supercharge your new business or to grow your existing business.

The type of financing you get will vary depending on your business type, but there’s one thing everyone should be cautious about origination fees.

If you’re in a situation where you need quick cash, don’t succumb to overlooking all the fees associated with the loan.

One of the fees that many lenders charge are called origination fees.

Related Article:Why Collateral Matters When Getting a Small Business Loan

What Are Loan Origination Fees?

Loan origination fees are fees that the lenders charge the borrowers for issuing you a loan. It can be called a service fee, closing fee, or a commission fee. These fees vary from lender to lender, but it can cost upwards of six percent. So if you’re taking out a business loan for $50,000 with a five percent origination fee, you’ll pay $2,500 in fees.

This fee is automatically taken out of your loan proceeds, so the exact amount you’ll receive is $47,500. On top of this, even though you only receive $47,500, you’re still paying interest on the original $50,000 loan amount. With this being said, it’s important to calculate exactly the amount you’ll need to run your business. If you need $50,000, you might need to request a higher loan amount.

Here are some examples of what some business lenders charge:

  • Bond Street: 0-3 percent
  • Kabbage: No origination fees
  • Funding Circle: 0.99-4.99 percent
  • DealStruck: 3-4 percent
  • OnDeck: 0-2.5 percent

Scenarios to Think Through

Now that you know how origination fees work, one of the most important things to think through is your time frame to pay back the loan. In some situations, it might be better off taking out a business loan without any origination fees but pay a higher interest rate. For example, if you have an opportunity to fill a customer but the supplies/distributor needs to be paid today, you should consider taking out a loan without any origination fees.

The simple logic behind this is that you’ll pay less overall interest than paying origination fees + interest. This also highlights the importance to make sure the lender doesn’t have any prepayment penalties. On the other hand, if you’re going to need the funds for a longer period of time to grow and expand your business, taking out a loan with an origination fee and lower interest rate might benefit you more. It’s always going to be a case by case scenario that you’ll have to evaluate before making the final decision.

Related Article:5 Reliable Tips for Selecting the Right Business Loan

Same Goes With Personal Loans

Most businesses that haven’t been in business for more than a couple years with an established revenue stream might find it difficult to get approved for a business loan. This is when a personal loan can be a good substitute for a business loan. There are some personal loan lenders that charge an origination fee such as LendingClub and Prosper and a few that don’t such as Avant and Sofi. Here’s a quick example of how origination fees impact your personal loan terms.

You should take the same precautions when applying for a personal loan:

  • Check to see if there are any prepayment penalties
  • Figure out exactly when you expect to pay the loan back (is it short term or longer term)
  • Calculate whether it’s best to pay an origination fee or take out a higher interest rate loan
  • And lastly but not least, check out reviews for each lender

What if You Get Denied for a Business or Personal Loan?

It's not the greatest feeling to get denied for a loan, but it happens more often than not. Thankfully, there are other creative ways to get the funding you need for your business.

Crowdfunding

Nowadays, you can crowdfund for almost anything, including your business. Setting up a crowdfunding campaign is a piece of cake and takes under 10 minutes. One way to incentivize your backers is to create various rewards or tiers that reward your backers based on the dollar amount they contribute. 

Credit Cards

It's not the worst idea to put charges on your credit cards to fund your business. The benefit to this is that it won't require any collateral at all. You can charge your card up to the limit and pay it off the next month, essentially "recycle" your available credit. You can do this until you either A) improve your credit score or B) generate higher revenue to qualify for a business or personal loan.

Related Article:5 Surprisingly Cheap Forms of Small Business Financing

Ask Friends and Family

Borrowing money from friends and family isn't necessarily the best conversation. You can set up a special payment arrangement with a simple promissory note to get the funds you need. If you go this route, tread with caution. The last thing you want to do is to risk losing this invaluable relationship that can be broken. Make sure you can comfortably pay them back and keep an open communication at all times, even if it's bad news.

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