Ever been attracted to the shockingly low advertised business loan interest rates in Singapore that banks offer, only to find out that the true interest rate charged to your SME loan is so much higher? Well, this is because of Effective Interest Rate (EIR).
What Is Effective Interest Rate On Loan?
They are also known as the Effective Annual Rate, which is the true cost of borrowing. Differing from the simple interest rate, the Effective Interest Rate takes into account the effects of compounding and other factors like the frequency and number of compounding periods. EIR’s meaning in technical terms is the total cost of borrowing a loan, expressed as a percentage of the total amount borrowed.
The Importance of Understanding Effective Interest Rate
Though the Singapore government offers small and medium sized-enterprises (SME) grants like the Enterprise Development Grant (EDG), businesses in Singapore may need short term cash flows across multiple periods in the financial year. It is usually insufficient to rely solely on government grants. Thus, SME often take up small business loans with lenders such as Poss, to help with their cash flow management.
SME loans in Singapore requires interest rate payments with cash multiple times a year according to the loan tenure, affecting cash flow management. Loan tenure refers to the amount of time businesses are given to repay their business loan. Thus, it is crucial to understand how the effective interest rate in Singapore affects your choice of business loan to take up.
1. Effective Financial Planning
SMEs in Singapore are on tight financial budgets, hence knowing the effective interest rate allows business owners to understand the true cost of borrowing. Businesses can then make informed decisions on whether to commit to the business loan.
2. Better Budgeting and Cash Flow Management
SMEs are able to forecast their future cash flows more accurately and meet their financial obligations without experiencing cash flow shortages, which can be detrimental to the financial stability of the organisation.
Moreover, effective cash flow management enables SMEs to seize business opportunities for growth and investment. By knowing your cash position, your SME can make the best investment decisions to boost the business.
3. Comparing Effective Interest Rate of Loan Options
Knowing how to calculate the Effective Interest Rate allows small business owners to compare different business loan offers side-by-side, enabling them to choose the most worthwhile option.
Now, you might wonder if it’s better to opt for a SME loan with a lower or higher EIR… In general, a lower EIR is better as it entails less interest rate in Singapore. However, other factors matter as well. Take for example, Business Loan A with an EIR of 2% and a loan tenure of 10 years versus Business Loan B with an EIR of 3% and a loan tenure of 5 years.
| Business Loan A | Business Loan B | |
|---|---|---|
|
EIR |
2% |
3% |
|
Loan Tenure |
10 Years |
5 Years |
|
Total Interest Paid |
20% |
15% |
By only warranting considerations for a lower EIR, some organisations might choose Business Loan A. However, in the long run, businesses spend more on loan interest rate expense when they choose loan A as compared to when they choose loan B. In this case, choosing the business loan with the lower EIR is undesirable for profit maximising firms. Therefore, careful deliberation is crucial to select the most optimal SME loan in Singapore.
Challenges SME might face when Securing Business Loan
There are many reasons why traditional banks are unwilling to lend funds to SMEs in Singapore, making business loans for newer companies difficult to secure.
1. Applying to Unsuitable Banks
Numerous banks and financial institutions cater to SMEs, each with their own credit criteria and risk tolerances. It can be a challenge to determine which banks align with your business profile. As a result, many business owners opt to apply to multiple banks simultaneously.
Lots of time is wasted in sourcing and engaging with banks that might not be suited for your unique business needs. Since banks rarely publicise their credit criteria in detail, identifying which financial institutions’ lending parameters suit your business can be a hurdle without additional professional help.
2. Insufficient Credit History
A low credit score can adversely impact your eligibility for small business loans in Singapore. Banks assess a business’s past payment history and credit reports to gauge its ability to repay their loan promptly.
For new businesses, establishing a robust credit history takes time, posing further challenges in meeting banks’ lending criteria. Consequently, banks often rely on personal credit reports to evaluate creditworthiness. Business owners with less than perfect credit histories face greater hurdles in securing business loan approvals needed for their day-to-day business operating activities.
Next Step to Secure a Business Loan after Understanding Effective Interest Rate
The process of securing suitable small business loans might seem clearer. However with other multi-faceted options to consider, being able to pick the best business loan might not be as straightforward.
Working with a Transparent and Knowledgeable Private Lender
If you prioritise transparency and expert guidance, you can consider Poss Capital as an alternative source of business financing for your SME. We recognise the financial hurdles that SMEs in Singapore encounter while striving to sustain or expand their business operations.
We provide clear business financing options catered to your needs. Learn more about our business financing solutions to find the one most suited for your business. Get in touch with us today and allow Poss Capital to support the growth of your small business.
