It can be confusing to navigate all the available loan products being offered by banks, lenders, and online financial companies these days. The best way to know which loan is best for your business situation, however, is to know about each of them in advance.
From long-term financing to a quick cash advance, the more you understand, the more likely you are to narrow down the long list to just those that work for you. Then, you can just apply to those that meet your finance goals and are most likely to approve you.
Traditional bank loans
These are the loans people think of first when considering small business financing options for their companies. While not quite a cumbersome as those loan application meetings we see in old movies, they can be a complicated and often lengthy process. While most are agreeable to online applications, the majority still require a face-to-face meeting.
Existing bank or credit union customers might get a reduction in the already-low interest rates of 3-6%, as well; these are usually offered if you’re willing to make automatic payments from a connected account at the same institution. Many of these loans are considered long-term loans, especially if they are used to buy real estate.
The SBA loans are a category in themselves. The most popular include the SBA 7(a) loan, the SBA 504 loan, and the SBA microloans. Each gives you a different loan amount, rates, and approved uses for the money. The different SBA loan terms also include how long you get to pay them back and how long you have to wait from the date of application until you get your money.
For the borrower in a hurry, SBA loans might not be the best choice, although SBA express offerings are shortening that timeframe for qualified businesses with excellent credit who need an approval answer within a few days. SBA loan rates are also very competitive – among the best in the industry, at 7.5 – 10%.
The exact definition of a medium-term loan will vary by industry or financial institution, but many brick-and-mortar institutions define them as those that need to be paid back within 2-5 years and often require collateral as security. If your credit score is excellent, however, it’s possible to get one without security. Interest rates can vary, hitting 30% at the peak.
Usually offered by online lenders, short-term business loans are designed to be repaid within a few months but can sometimes last 18 months. Those will excellent credit will benefit the most from these, paying similar rates to other loans. Those with subpar credit histories, however, can often pay up to 80% for financing through medium-term loans.
Business lines of credit
These popular small business loans give you funding like a traditional loan but offer you access like a credit card. You can borrow just what you need, as long as you don’t go over your limit and pay the minimum owed each month.
Lines of credit may charge interest, monthly or annual fees, or a mix of both. Note that many of them will charge interest (at a rate of 7 to 36%) on day one, unlike credit cards, which often come with a 21 to 30-day grace period.
If you just need to upgrade your grills, factory lines, or 3D printers, and not pay for other working capital types, the equipment financing option may be for you. With an APR of anywhere from 8 to 30%, getting a good deal will entirely depend on the loan amount and your business credit score.
A good personal credit score, along with the equipment you’re financing as collateral, could help a borrower lower their rate. Equipment loans are rarely considered short-term financing, with much longer repayment periods than some other financing options.
Many new businesses may have trouble getting financing when they have a short history to demonstrate their track record. That’s why invoice financing is popular among startups and others who have billed for products and services, but just haven’t been paid yet.
By getting a loan based on future accounts receivable, the lender is assuming the low risk. Expect to pay a bit more for the privilege, however; invoice financing can be among the most expensive in the industry, from 13 to 60% APR.
Merchant cash advance
One of the more expensive ways to borrow money, the application process is super simple. The lender uses your credit card sales records to determine how much cash flow you normally have, then offer you a cash advance based on those numbers.
To pay the loan back, a small percentage of each credit card sale will be taken. You’ll need to do a bit of planning to accommodate the repayment of the loan, but it’s a loan option that is available to those with even less-than-excellent credit scores. The cost to borrow in this manner, however, is high. Some accounts may be charged an APR of over 100%!
With all of the loan types we explored, they will each have their own rules or “terms.” This isn’t to be confused with “term loans.” These are simply any loan with predetermined repayment terms. Unlike a line of credit or credit card, which can be paid and then borrowed against again and again, term loans have a set loan amount and repayment period to meet. Easier to get than some standard bank loans, they are most usually offered online and may have higher fees or APR.
Common Business Loan Terminology
In addition to understanding the various types of loans, there are many additional factors that can affect the affordability of your loan, how you repay it, and the value you get from it. Since many of the terminologies will also be included in your application and loan contract, it’s smart to familiarize yourself.
These common loan terms are used by most banks, and even just one can be the difference between an affordable monthly loan payment and something that can make repayment difficult.
Accounts receivable (or “AR”) is a term used to describe all the monies that a company is owed but hasn’t collected yet. For most businesses, this can be measured by invoices created or sent but not paid.
Accounts receivable is a key indicator in the health of a business, and some business lenders will issue credit based on the total AR outstanding at any time.
Whether a fiscal business year starts in January, or some other month, the total twelve-month sales done by a company is its annual revenue. Not to be confused with profit, it is the gross amount collected, not including business expenses or debt yet to be paid.
Anytime you apply for a credit card or loan, you’ll see the term “APR.” Short for Annual Percentage Rate, it calculates the cost to borrow money. It combines the compounding business loan interest rate and fees into one number, giving you a better overall view of what you can expect to pay to borrow money in a given year. Most lenders will share the APR freely with you before you apply, but if they don’t, a simple APR calculator can help.
Business credit scores
Just like you have a personal credit score that documents your creditworthiness, you can also have a score for your business. This will track things like on-time payments, amounts owed, variety of debts, and length of credit history.
The better business credit score you have, the more likely you’ll be to qualify for those great interest rates on loans and credit cards!
Business credit reports
Business credit reports can be pulled in the same way personal ones can, but they aren’t automatically generated just by being in business. To ensure that your on-time payments are being tracked and recorded in your history, ask your vendors and merchants if they can report your on-time payments to credit bureaus. A credit report can take time to build, but it’s worth it.
Cash (and cash equivalents) coming in and out of a company is its cash flow. This includes money being paid to the company by customers and payroll going to employees from the business.
Money flowing in and out, measured by reports, is its cash flow. Companies try to focus on cash flow coming in and increase that number over time.
Many loans are considered secured loans. That is, they require you to put something of value that you already own for security in case you can’t make payment. This item is referred to as “collateral.” It can be the actual item you are financing (such as a house or car) or an unrelated item.
If you were to take out a $1 million-dollar loan to refinance debt, for example, the bank may ask that you offer up a piece of collateral unrelated to the loan to ensure that they aren’t taking unnecessary risk. Your home or a piece of business property might be used to secure the loan to the bank’s satisfaction.
According to the makers of the FICO (Fair Isaac Corporation), it is calculated based only on information received from the three credit bureaus. “By comparing this information to the patterns in hundreds of thousands of past credit reports, FICO Scores estimate your level of future credit risk, or how likely you are to repay a loan on time.” FICO claims that 90% of top lenders use their scores.
When you borrow money and put up your car or home as collateral, you are granting a lien to the bank for that item. If you were to then not be able to pay the loan, the bank could seize the car or home to help them recover the losses.
If you are financing an item with a loan (such as business equipment), the lien would usually be put against the item being financed. A loan without a lien is considered an unsecured loan.
The difference between a secured loan and an unsecured loan can be a big one. With unsecured business loans, you aren’t offering up any collateral to guarantee payment. If you were not to make your monthly payments, the bank has nothing to take from you to help them recover what they are owed.
A secured loan, on the other hand, uses something as collateral – either the item the loan is paying for (such as a piece of property, a car or equipment) or another item put up to help secure the loan.
Many small business loan terms, especially those through SBA-approved lenders, dictate how you use the money. Working capital is one of the allowed ways to spend loan funds. Working capital is comprised of all of the liquid assets (such as cash) and other assets that can be accessed easily to pay for the daily operations of a business.
When businesses get funding to use as working capital, they spend it on everything from payroll to raw materials to paying the light bill.
Frequently asked questions
It’s impossible to cover all the nuances of various business loans and standard funding in one article, but the questions people usually have are also mentioned here:
What’s the benefit of a business loan payment calculator?
Like any other loan calculator, business loan calculators can tell you a number of things, including how much your monthly loan payment will be for the length of the loan, the amount of the loan, and various origination fees and interest rates. These can help you plan out your monthly budget.
Simply tweak the monthly loan amount to what you can afford to see what you should borrow. Likewise, you can lengthen or shorten the loan term to see how much long-term business loans will cost compared to a short-term loan.
How do SBA loan terms differ from other loans?
SBA loans aren’t actually given out by the SBA. The Small Business Administration matches lenders with qualified borrowers and often subsidized the loan to help reduce risk to the lender and encourage them to offer more loans to less-qualified businesses owners.
Because of this, the loan terms come partially from the SBA and business lending guidelines under the program, but lenders also have some flexibility in how they lend. Rates (within a range), payment terms, and other considerations may be set by the lender independently from the SBA.
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