Demystifying APR: A Step-by-Step Guide to Understanding the Cost of Your Line of Credit
Ever wonder what APR actually means and how to calculate it? Read our blog post below to learn more about the importance of understanding APR to evaluate your true cost of borrowing.
When it comes to managing finances for a consumer brand, understanding the true cost of capital is crucial. One of the most important metrics to grasp is the Annual Percentage Rate (APR), especially in the context of a line of credit.
As a reminder, Ampla offers a flexible Growth Line of Credit to help consumer businesses build inventory, pay vendors, fuel marketing spend, and more.
APR encapsulates not just the interest rate, but also additional fees and costs associated with borrowing. Below, we’ve outlined a foundational walkthrough of what an APR is and how to calculate it on a line of credit, empowering you to make informed financial decisions as you seek capital solutions for your brand.
Understanding APR and its Significance
Before we dive into the calculations, let's establish a clear understanding of what APR is and why it matters. An APR represents the annualized cost of borrowing, including both the interest rate and any applicable fees. Unlike a simple interest rate, which only considers the interest charged on the principal amount, an APR provides a more comprehensive view of the financial commitment associated with a line of credit.
Step-by-Step Calculation of APR on a Line of Credit
Start by collecting all the necessary information about your line of credit. This includes:
- Principal Amount: The initial amount you’re looking to borrow.
- Interest Rate: The annual interest rate charged on the borrowed funds.
- Fees: Any upfront or recurring fees associated with the line of credit. Note that with Ampla, we do not charge any additional upfront or recurring fees outside of the interest rate, making it one of the more affordable options available to consumer brands.
- Loan Term: The duration for which you'll be borrowing the funds.
Multiply the principal amount by the annual interest rate to determine the interest cost for a year. For instance, if you've borrowed $5,000 at an interest rate of 10%, the interest cost for a year would be $500 (5000 * 0.10).
Factor in Fees:
Add up all the fees expected to be associated with the line of credit over its lifetime, and divide by the expected lifetime of the line of credit. This could include application fees, annual fees, monthly fees, termination fees, and any other charges. For example, if you have $100 in total annual fees, add this to the previously calculated interest cost ($500 + $100 = $600).
Again, at Ampla, we pride ourselves on accessibility and transparency, and it’s for that reason that we don’t charge any additional fees that you may find with other partners, such as underwriting fees, fees for unused credit, etc.
Determine the Total Repayment:
To calculate the total amount you'll repay over the loan term, add the principal amount to the interest and fees. If your principal is $5,000 and the total interest and fees amount to $600, your total repayment would be $5,600.
Account for the Duration of the Loan:
To truly understand the cost of borrowing, you need to account for the number of days it will take you to repay the total balance (principal and interest). For example, if you plan on paying the loan back over the course of six months, that’s approximately 180 days.
With Ampla, we don’t set predetermined payback periods or terms, which is a big part of what makes our Growth Line of Credit a preferred choice for brands. We simply assign a collection percentage to your line of credit, and take a share of your daily revenues until the principle and interest are paid in full. If your revenue slows, so does our repayment schedule.
Once you’ve determined your principal, interest plus fees, and duration of outstanding debt in days, you can run the math.
- Step One: Take the total interest plus fees, and divide by the original principal. In this instance, that would be 600 / 5000 = .12
- Step Two: Divide by the number of days in the loan’s term, or .12/180 days = .00066667
- Step Three: Multiply the above result by 365 to account for the total number of days in the year, thus annualizing the costs to .2433 or 24.33% APR
The Importance of Calculating APR
Calculating the APR empowers you to make more informed financial decisions by allowing you to compare different credit offers on an equal footing. It helps you understand the true cost of borrowing and avoid hidden charges that might not be apparent when only considering the interest rate. By factoring in ancillary fees as well as loan duration, you’ll gain a clearer picture of the financial commitment you're undertaking.
If you’re comparing a variety of lending solutions, specifically flat fees versus lines of credit, we’ve created an easy-to-use calculator that will convert your flat fee offer to an APR so you can truly compare apples-to-apples and determine your cost of capital.
At Ampla, we pride ourselves on the simplicity, transparency, and flexibility of our Growth Line of Credit via a simple APR pricing model. For brands looking to secure non-dilutive capital, you can reach out to sales today and learn more.