What You Need to Know When Shopping for a Business Loan
When you‘re getting a business started, you‘ll likely be funding it through your own savings. Although this works in the early stages, there typically comes a point where the only way to get the kind of growth you want is to obtain a business loan.
A business loan could be just what you need to expand your inventory, open another location or buy some much-needed equipment. There‘s a lot to know about business loans before you apply, and this guide will cover the types available, interest rates and how to apply.
Popular Business Loan Options
Here are a few of the most common business loan options on the market:
Short-term loans – These loans usually have terms of 12 months or less and smaller amounts.
- Long-term loans – These loans are for large amounts, and their terms typically last for years. Payments are made monthly.
- Lines of credit – These are technically not loans but revolving lines of credit. You have a credit limit, which is the most you can borrow. As you pay back what you borrow, your available credit goes up and you can borrow more again. Interest rates tend to be higher on these than they are with loans.
- U.S. Small Business Administration (SBA) loans – The SBA backs these loans, which are offered by banks and other financial institutions. This gives the lender more protection and makes it easier for borrowers to get approved.
- Equipment loans – These loans can only be put towards the cost of specific equipment, which then serves as the collateral on the loan. The lender has less risk, because they can repossess the equipment if you default, making it easier to get these loans. They also tend to have low interest rates.
Standard Business Loan Interest Rates
The interest rate a lender sets for a business loan depends on its level of risk. The lender will start with the prime interest rate, which it uses as a baseline, and then it will add a certain amount to that rate.
The standard interest rate for a business loan is anywhere from 8 to 12 percent. That‘s higher than the average for a mortgage, since business loans have a greater risk.
Your interest rate will depend on your situation and your lender. If you have a startup, you‘ll probably pay a higher interest rate than you would if you had an established business that has been successful for a decade. Banks usually offer lower interest rates than third-party lenders, but they‘re also stricter about who they‘ll approve for a loan.
The Difference Between Secured and Unsecured Business Loans
Just like other types of loans, business loans can be secured or unsecured. Secured means that there is some form of collateral on the loan, while unsecured means that there‘s no collateral and the borrow is only giving their personal guarantee on the loan.
Here‘s a closer look at each type of loan, including the pros and cons:
Secured Business Loans
- There was already one type of secured business loan covered above – the equipment loan. The equipment purchased with the loan secures it.
- Another common type of secured business loan is debt factoring. With this type of loan, you‘re essentially selling unpaid invoices your business has to a financial institution. That financial institution pays you a portion of the value of those invoices, usually up to 85 percent, and then collects those invoices.
- With secured business loans, the lower level of risk means you can secure a lower interest rate and borrow more money. You‘ll also usually have more time to pay back what you borrow, resulting in a smaller monthly payment. {' '}
- The only drawback with secured business loans is that you could lose whatever you put up as collateral. It‘s never good to default on a business loan, but it‘s even worse when defaulting will text-base text-gray-900 to the repossession of an asset.
Unsecured Business Loans
- When you get an unsecured business loan, approval for the loan depends only on your income and your credit score. There are many examples of unsecured consumer loans, including personal loans and student loans.
- The obvious benefit of an unsecured business loan is that there‘s no risk of losing any assets. Your credit score will still be in big trouble if you default on the loan, but the lender can‘t take anything you own.
- Since the lender is relying on your guarantee that you‘ll pay off your loan, they will be stricter regarding who they approve. For an unsecured business loan, you‘ll likely need a high personal credit score, multiple years in operation and a certain minimum amount of annual revenue. The application process will take longer because the lender needs to carefully evaluate your financial situation, the amount you can borrow is lower and your interest rate will be higher.
The Business Loan Application Process
When you apply for a business loan, the lender will run a hard credit inquiry to check your score. They‘ll also take a thorough look at your business‘s cashflow every month and your assets. You‘ll need to bring your financial records to show the lender.
If you have a business that is doing well in terms of profitability and has a solid operational history of at least five years, you‘ll likely be able to get a business loan easily enough. It‘s more difficult for younger businesses, as there‘s less proof that your business will have long-term success.
You‘ll need a good business plan written out to show the lender. This plan should include how you plan to use the money from the loan to grow your business and its profits. Fortunately, there are business coaching services available through the SBA for free, and these can help you create a good plan.
The hard credit inquiry the lender runs when you apply for a loan can bring your credit score down a bit. Although this isn‘t a big deal, it can be if you get denied and need to apply for multiple business loans, as your score will decrease each time. That‘s why it‘s so important to put your best foot forward when you apply and only apply when you think you have a good shot at an approval.
Getting a business loan isn‘t a decision to take lightly. Understand your various loan options, choose the one that‘s right for your business‘s needs and get everything you need ready before you apply.