Business loans or lines of credit account for 76% of the financing small businesses sought out, according to a 2022 report from Fed Small Business, a project of the U.S Federal Reserve. Below, we’ll dive deeper into the types of business loans, what to watch out for, and how you can apply for one.
Should You Get a Business Loan?
The versatility of business loans might benefit you in several situations. For example, If you’re a new business, a small business loan can:
Build business creditHelp manage cash flowFund startup costs such as equipment and inventory
If you’re an established venture with plans to expand, a small business loan can help you or quickly build an emergency fund to cover unexpected expenses. Avoid using a small business loan to pay for a depreciating asset that won’t increase in value or generate income. You should also avoid small business loans with high fees, interest rates, and unfavorable loan repayment terms. A small business loan should help increase the future value of your business rather than decrease it.
Types of Business Loans
Not all small business loans are created equal. There are many different types.
Term Loans
When most people think of business loans, term loans come to mind first. With a term loan, you receive a lump sum of money upfront and repay it over time, usually through fixed monthly payments or installments. Term loans typically are unsecured, meaning you don’t need collateral such as commercial property or equipment to take them out.
SBA Loans
The U.S Small Business Administration offers a variety of loans partially guaranteed by the SBA and issued by private lenders; these loans may be available to businesses banks won’t lend to due to risk. Programs include 7(a) loans for a wide variety of purposes, 504 loans to repair or purchase assets, and microloans of $50,000 or less.
Business Line of Credit
A business line of credit is a flexible loan that works like a credit card. It can be secured or unsecured. Upon approval, you can withdraw funds up to a set credit limit. You then pay interest on what you’ve borrowed. A business line of credit is ideal if you’re a seasonal business, need to pay for working capital, or have emergency cash at your disposal. You pay interest on the credit used.
Equipment Loans
Equipment loans are exactly what they sound like: loans to help you pay for new or used business equipment, such as heavy-duty machinery, computers, and other types of technology. Since the loans are secured to the equipment and the lender can seize the equipment if you default, equipment loans may be easier to acquire.
Other Business Loans
Other business loans you might investigate include:
Commercial real estate loans: Loans to purchase land or commercial buildings you need.Business auto loans: Loans to buy cars, vans, and trucks your business needs.Specialized loans: Medical-practice loans help physicians start a business, while farm loans help create, expand, or maintain a family farm.State loans: Some states offer small business loans, including for businesses facing difficulties acquiring financing.
What You Need To Apply for a Business Loan
Most lenders will request certain documents and information when you apply for a small business loan. Before you begin the application process, ensure you have the following on hand:
Legal documents: Business licenses and registrations, articles of incorporation, franchise agreements, and commercial leasesBusiness plan: Outlining who you are, what you do, and how you intend to use the funds to meet your goalsIncome tax returns: Business returns and personal tax returns of ownersFinancial statements: Balance sheets, income statements, and statements of cash flow; accounts receivable and payable; financial projectionsResumes: To demonstrate the management team’s experienceBusiness credit report: To showcase your business history regarding borrowed money
Collateral
Some business loans require collateral, which is something valuable your business owns. This may be equipment, inventory, invoices, or commercial real estate. If you fail to make your loan payments, the lender can take your collateral and sell it to recoup some of their losses. A collateral secured loan is only a good idea if you’re confident you can repay it according to your contract’s terms. However, a loan secured with collateral will also usually offer lower interest rates.
Shopping Around for the Best Loan
Small business owners frequently state that challenges with lenders include a difficult application process, long wait for credit decisions or funding, high interest rates, and unfavorable repayment terms, according to the 2022 Fed Small Business report. Compare interest rates, repayment terms, fees, and penalties of all the loans you find, so you can borrow the ideal product. Ensure you can fit new loan payments into your monthly budget.
How Much Will I Get From a Loan?
Lenders want to ensure you can make regular payments on your loan using regular income or revenue, along with your credit history. As a result, amounts can differ significantly—the SBA lends a range from $500 to $5.5 million. The amount you’ll qualify for will depend on a number of factors including:
LenderLoan typeYour personal or business credit scoreAnnual revenueBank statements and balance sheetsCollateral or assetsTime in business
In general, the criteria lenders are looking for include:
A higher credit score An average daily balance of more than $10,000 Low liabilities on credit cards or other loans Debt service coverage ratio less than 1.25 or 1.35 times business expenses
Loan approvals dropped after the pandemic—only 68% were approved in 2021, compared to 83% in 2019. If you’re unhappy with the denial or the approved amount, focus on improving your credit and reapply at a later time. To do so, pay your suppliers and vendors early, monitor your credit reports and correct any errors or inaccuracies, and keep debt levels low.
Applying for a Business Loan: A Step-by-Step Guide
Once you’re ready to apply for a small business loan, follow these steps.
How To Repay Your Business Loan
Once you receive your loan, it will be your responsibility to repay them. In general, you should repay your business loan similarly to a personal loan. Keep track of your debts and payments, and find ways to increase business income and reduce spending. You repay term loans over time through fixed monthly payments. If you chose a line of credit, you could make a minimum monthly payment. When you repay the amount you’ve drawn plus any interest, those funds will be available for you to use again. Do your best to pay off your loan on time or your credit will take a hit and make it difficult for you to secure business financing in the future. You can also repay your loan early to reduce debt and gain peace of mind. To do so, make biweekly payments, round up your monthly payments, or make one extra payment each year.
