Rate Transparency in the Alt-Fi Market

Loans with different rate structures can look cheap at first but could be more expensive in the long run. Our Head of Credit & Underwriting investigates.

By Stacy Clementson

Business loans should be priced fairly and transparently, but with most SME lending in the UK being unregulated, comparing loan offers can cause challenges for brokers and borrowers alike.

Without a standard way of presenting rates, many SMEs struggle to understand the true cost of their finance, often ending up paying more than they realise.

The challenge of different rate types

Lenders use various methods to display their rates, from daily interest rate to factor rate, as well as some more unconventional methods not widely recognised.

Each of these rates tells you something different about the cost of a loan, and they aren’t always easy to compare. For instance, a loan advertised with an 8% annual interest rate might seem cheaper than a loan with a 10% flat rate, but the reality is often more complicated.

Let’s look at some real-life examples.

Example 1

Suppose you have two loans for £100,000 over 60 months:

Loan 1: Factor rate of 1.27
Loan 2: Monthly interest rate of 1.15%

At first glance, Loan 1’s factor rate of 1.27 might look high, but it’s important to note that this doesn’t directly translate to a monthly interest rate. The real equivalent monthly interest rate is around 0.82%. This is a lower monthly interest rate than Loan 2 offers, and therefore the interest costs over the term are lower - in this case, nearly £12,000 lower.

Example 2

Now, let’s compare the same rates for a £100,000 loan over a 12-month term.

In this case, the equivalent monthly interest rate of Loan 1 would be 3.88%. This is significantly higher than the monthly interest rate offered by Loan 2, and the overall cost of Loan 2 would be nearly £20,000 cheaper in this instance.

These examples highlight why rate transparency is essential. If all rates were shown in the same way, it would be easier to compare them and make informed decisions. Without a clear understanding of how different rates translate into actual costs, borrowers are at risk of overpaying and brokers may struggle to provide accurate advice.

Total costs count

To make a clear comparison, borrowers need to compare the total repayable amount for each deal, including all fees and charges, not just the rate type.

Loans with different rate structures can look cheap at first but could be more expensive in the long run. For instance, while a flat rate might seem straightforward, it often results in higher overall costs compared to loans with annual or monthly rates when assessed over the same term.

The term of the loan also plays an integral role in determining the true cost. For shorter loans (6-12 months), if you extend the term, this can increase the effective factor and yield rates if you’re using a monthly rate for comparison.

As a result, a direct comparison of factor rates with annual or monthly rates can be misleading unless the terms are adjusted in line with one another.

And, most importantly, ensure that the payment and the frequency of those payments work for your client’s business - not just the overall cost. This ultimately ensures it has cash availability to meet its obligations, survive, and thrive.

Making sense of loan offers

Standardising how rates are shown would make it easier to compare loan offers and understand their true cost, without being misled by seemingly low rates. This way, brokers and borrowers can make better decisions and avoid confusion.

In a largely unregulated market, the onus is on lenders to provide clear and transparent information. Without standardised regulations, the risk of borrowers being misled or overpaying increases. This makes it even more important for brokers to advocate for their clients by ensuring they fully understand the total repayable amount and all associated costs.

To help make comparisons easier, it’s useful to have tools that show the total amount repayable. Fleximize’s Rate Comparison Tool helps SMEs compare loan quotes and gain a better understanding of the real cost. Using such tools helps you and your clients get a clear picture to make well-informed financial decisions and secure fair and transparent loan options.

(As seen in Issue 119 of the NACFB Commercial Broker magazine.)