APR and the Key Fact Statement: the true cost of a loan

The headline rate is not the cost

Apart from interest, a business loan can carry several charges. Each one either reduces the money you receive or increases what you repay.

• Processing fee — usually a percentage of the loan, often deducted from the amount disbursed.
• Insurance premium — credit life or asset insurance, sometimes financed within the loan.
• Documentation, legal, valuation and stamp charges.
• Guarantee fee — where the loan is covered under a credit guarantee scheme.
• Taxes — GST applies to most fees.
• Contingent charges — for bounced instalments, late payment, pre-payment or changing the repayment date.

Flat rate and reducing-balance rate

Under a reducing-balance rate, interest is charged each month only on the principal still outstanding. As you repay, the interest falls. Under a flat rate, interest is charged on the full original amount for the whole tenure, even though you are steadily repaying it. The same number therefore means very different costs.

Take a hypothetical loan of ₹10 lakh for three years, quoted at 12 per cent each way.

The flat-rate loan costs nearly twice as much in interest. Whenever a rate is quoted, ask which kind it is, and ask for the reducing-balance equivalent.

APR: one number for the whole cost

The annual percentage rate (APR) expresses the total cost of the loan — interest plus all the fees and charges you must pay to get it — as a single yearly percentage of the money you actually receive. It is the correct basis for comparing loans.

The shorter the loan, the harder upfront fees bite, because the same fee is spread over fewer months. A fee that adds one percentage point to a five-year loan can add several points to a one-year loan.

The Key Fact Statement

The Reserve Bank of India requires regulated lenders — banks and NBFCs — to give borrowers a Key Fact Statement (KFS) for retail loans and for term loans to micro, small and medium enterprises. It is a short document in a standard format, in a language the borrower understands, given before the loan agreement is signed. It sets out:

• the loan amount, tenure, interest rate and whether the rate is fixed or floating;
• every fee and charge, including amounts collected for third parties such as insurers;
• the APR, computed to include those charges;
• the repayment schedule, instalment by instalment;
• contingent charges such as penal and pre-payment charges;
• details of recovery agents and the grievance redress mechanism.

Two protections follow from it. You get a period, stated in the KFS, during which the terms offered stay valid, so you can compare them without pressure. And a fee or charge that is not mentioned in the KFS cannot be levied during the loan without your explicit consent. Read the KFS, keep a copy, and query anything that differs from what you were told.

Penal charges and pre-payment

If you miss an instalment or breach a loan condition, a regulated lender may levy penal charges, but RBI rules require these to be charged as charges and not added to the rate of interest on the loan. Interest is not to be charged on the penal charges themselves, and they must be reasonable and disclosed upfront.

Pre-payment terms deserve equal attention. If you expect to repay early from a large receipt, a foreclosure charge can cancel much of the saving. RBI rules bar pre-payment charges on many floating-rate loans, including business loans to individuals and to micro and small enterprises, subject to conditions; other loans may carry a charge. Check what your KFS says before you sign.

Safeguards in digital lending

When a loan is sourced through an app or an online platform, RBI’s digital lending rules add further safeguards.

• The loan must be disbursed directly from the regulated lender to your bank account, and repayments must go directly to the lender — not through the account of an app or agent.
• Fees payable to the platform or service provider are to be paid by the lender, not collected from you.
• You get a cooling-off period during which you can exit the loan by repaying the principal and the proportionate cost, without penalty.

If an app asks you to pay a fee into a personal account before disbursal, or cannot name the bank or NBFC behind the loan, walk away.

Comparing two offers

1. Put both on the same amount and the same tenure.
2. Compare the APR, not the quoted rate.
3. Compare the net amount you will receive after deductions.
4. Compare the total you will repay over the full tenure.
5. Check pre-payment and penal charges, especially if your cash flow is uneven.
6. Check whether the rate is fixed or floating, and what it is linked to.

The cheapest loan is not always the right one; tenure and flexibility matter too, as discussed in cash credit, overdraft, term loan or invoice discounting. Daily-priced facilities are covered in invoice discounting explained.

Vaanij Capital is a marketplace, not a lender. Offers come from regulated banks and NBFCs, you see them side by side and choose, and the lender you pick issues its own Key Fact Statement.

This article is general information for business owners. It is not financial advice — loan terms are set by the lender, so read the lender’s own documents before you commit.