True Cost of Capital: What Funding Really Costs You

Why the quoted rate is not the real cost

Offers use different pricing formats, so a stated rate cannot be compared directly. Total dollars repaid and the time you hold the money can.

A term loan quotes an interest rate. A revenue-based product quotes a factor rate. A line of credit quotes an interest rate plus draw fees. An SBA loan quotes a rate plus guarantee and closing costs. These are not the same measuring stick.

Two offers can have the same headline number and cost very different amounts, because of origination fees, shorter terms, prepayment rules and how often payments are taken. The way around the confusion is to ignore the label and ask three questions about each offer: how much do I receive, how much do I repay in total, and over how long.

Start with the total dollars: the cost line

Cost of capital in dollars equals total repayment minus the net amount you receive after fees. This is the cleanest figure to compare.

Here is the method in four steps.

1. Take the amount advertised.
2. Subtract every fee deducted at funding. That is the net received.
3. Add up every payment you will make. That is total repaid.
4. Subtract net received from total repaid. That is the true cost in dollars.

Offer A looks like it has fees, yet it costs less in dollars. Offer B has no fees but a higher payback. Only the full calculation shows that.

Add time: effective APR and monthly cost

Dollars alone ignore how long you hold the money. Converting cost to an annualized rate puts short and long offers on the same scale.

In the table above, Offer B costs $2,500 more but repays in 8 months instead of 12. Which is better depends on what you do with the money and how fast it comes back. A short term raises the annualized percentage even when the dollars are fair, and a long term lowers it even if the dollars are higher.

For a quick check, divide true cost by net received, then scale to a year: cost percent times twelve divided by months of term. Because payments reduce what you owe over time, this is only a rough guide, and a real APR calculation weighs the declining balance. Treat it as a way to compare, and use a proper APR figure when an offer provides one. Our posts on the 1.3 factor rate and daily payment to monthly equivalent work through real examples. See also business loan rates.

Fees and terms that raise the real price

Origination fees, closing costs, draw fees, monthly maintenance charges and prepayment penalties can all add to cost beyond the stated rate.

Read the fee schedule line by line. Items that often change the math:

• Origination or underwriting fees, usually taken from the proceeds.
• Draw and maintenance fees on credit lines.
• Guarantee and packaging fees on SBA financing; check the SBA for current figures.
• Prepayment terms: in some products you save little by paying early, in others you do.
• Late fees and default rates that apply if a payment is missed.

Ask whether paying off early reduces the total. With a fixed-factor product, it often does not. With an interest-bearing loan, it usually does.

Compare offers side by side

Put every offer in the same table with net received, total repaid, term, payment and cost. Choose by cost per dollar of benefit, not by the lowest payment.

Build a simple comparison with the same six rows for each offer: net received, total repaid, true cost, term, payment size and payment frequency. Our comparison worksheet lays this out.

Then add the cash flow lens. A lower payment over more months may be the right answer if cash is tight. A higher payment over fewer months may be right if the money pays back quickly. The cheapest offer on paper is not always the one your account can carry. Read more in the total cost of a funding offer.

Questions to ask every funder

A short list of questions gets the numbers you need out in the open.

Before you accept any offer, ask: What is the exact amount I receive after fees? What is the total I will repay? What is the payment amount and how often is it taken? Is there any benefit to paying early? What happens if I miss a payment? Are there any fees not listed in the summary?

Write the answers next to each other. If a funder cannot or will not state the total repayment in dollars, treat that as information. Clear answers are a sign of a straightforward offer, and the comparison becomes simple arithmetic.

Cost has to be measured against what the money earns

A cost is only high or low relative to the return. If the money produces more profit than it costs, the funding paid for itself.

This is the part most calculators skip. A $9,500 cost is expensive if the money sits idle, and cheap if it buys inventory that turns twice and produces $30,000 in extra gross profit. Estimate the gain before you borrow. Our guide on cost of capital versus ROI shows how.

ROI Funder starts from that same question. It shows the true cost, payback period and monthly-equivalent payment for each offer before you sign. Funding runs from $5,000 to $5,000,000, with a soft credit pull to apply and no obligation to accept.