META TITLE: How to Evaluate a Business Loan | True Cost Analysis Guide

How to Evaluate a Business Loan

The restaurant owner signed a $150,000 loan at "8% interest." Eighteen months later, he'd paid back $189,000. I asked him to calculate the actual rate. He couldn't.

The loan had origination fees of 3%, monthly payments that front-loaded interest, a prepayment penalty, and a factor rate structure instead of traditional interest. The true APR was 28%.

He'd have paid less on most credit cards.

Before you sign anything, learn what that loan costs.

Interest Rate vs. APR vs. Factor Rate

Lenders use different metrics, and the differences matter enormously.

The only number that matters: how many total dollars leave your account?

Calculate:

• Principal borrowed

• Total interest over the loan term

• Origination fees

• Application fees

• Monthly service fees

Total cost: $39,000

True cost: 26% over 18 months = 17.3% annualized

ACTION: Request a complete amortization schedule and fee disclosure from any lender before signing.

Monthly Payment Affordability

A loan you can't afford makes everything worse.

DSCR = Net Operating Income / Annual Debt Payments

A business generating $180,000 in annual operating income with $60,000 in annual loan payments has a DSCR of 3.0.

Lenders typically require DSCR above 1.25. For your own protection, target above 1.5. Below 1.25, you're living on the edge.

ACTION: Calculate your current DSCR. What's the maximum monthly payment that keeps DSCR above 1.5?

A business with $15,000 monthly operating income can afford about $10,000 in monthly debt payments at 1.5 DSCR. Every dollar above that increases risk.

Loan Term Considerations

Shorter terms mean higher monthly payments but less total interest.

Longer terms mean lower monthly payments but more total interest.

$100,000 at 10% interest:

3-year term: $3,227/month, $16,172 total interest

5-year term: $2,125/month, $27,480 total interest

7-year term: $1,659/month, $39,348 total interest

Personal Guarantee Analysis

Most small business loans require personal guarantees - your personal assets back the business debt.

A personal guarantee means:

• Your house, savings, and personal assets are at risk

• Business bankruptcy doesn't eliminate the debt

• Your credit score ties to business loan performance

Before signing a personal guarantee:

• Understand exactly what's at stake

• Discuss with your spouse/partner if applicable

• Consider life insurance sufficient to cover the debt

• Know the circumstance that would trigger personal liability

Some lenders offer partial guarantees (25-50% of loan value). Others require unlimited guarantees. Know which you're signing.

ACTION: List your personal assets that would be exposed by a personal guarantee. Are you comfortable with that exposure?

Cash Pulse Impact

Your Cash Pulse vital sign measures runway - how many days of operating cash you have.

New debt affects Cash Pulse in two ways:

Positive: Loan proceeds add to cash balance immediately.

Negative: Debt payments reduce cash monthly.

A $100,000 loan with $3,000 monthly payments increases Cash Pulse by 33 days initially (at $3,000 daily expenses) but reduces monthly available cash by $3,000.

Within 33 months, you've repaid more than you borrowed. The initial Cash Pulse boost disappears.

ACTION: Model how the loan affects your Cash Pulse over time. Does the borrowed cash generate returns before payments consume it?

Covenant Requirements

Many loans include covenants - ongoing requirements you must maintain.