Most small businesses need to borrow money sooner or later; whether they need cash for startup capital or to expand the business, a business loan will likely be needed. Business loans are fairly simple to understand, once you know the main components- principal, fees and interest.

Principal

Principal is simply the amount of the loan that you request, and the amount that you will pay back in addition to interest and fees. Typically, the other parts of your loan are interest and fees, based on how much you need to borrow. Therefore, the principal amount is the most important figure in the transaction.

Fees

Business loans often come with lending fees of two separate types.

Origination fees are most often a small percentage of the amount borrowed, and they cover costs of evaluating your credit and making the loan. You only pay origination fees if you accept the terms of the loan and receive the money.

Other fees added as upfront charges are application submission, loan processing, underwriting, and document preparation fees. Be sure that you understand all charges and deductions before you sign the loan documents.

Additionally, some lenders charge ongoing fees over the life of your loan, or if you pay it back early. While you may save money on interest by doing so, the prepayment penalty may cost you more overall.

Interest

The amount of money you pay the lender for loaning you their money is interest. The easiest loans to understand are simple interest – you borrow $1,000 and agree to pay it back in one year at 6 percent interest. Therefore, within 12 months, you pay back $1,060 dollars.

Alternatively, signing a loan which includes interest compounding means that you will pay interest on both the principal and interest. On our $1,000 example above, that would mean you would pay back $1,061.68, or an annual rate of 6.17 percent.

Compare loans to see which is the best for you by considering prepayment penalties and the annual percentage rate (APR) of each. Your lender should happily provide that information to you so that you can make the right funding decisions, and he or she can gain a long-term customer.