25.1 C
New York
Monday, June 24, 2024

How do business loans work?

Must read

Are you prepared to start or grow your small business? As an entrepreneur, it can be costly, and you may have to apply for a small business loan. Like any other loan, a business loan is a sum borrowed from a lender that must be repaid, with interest and fees, within a specific time frame.

To acquire a small business loan, you must meet the specific requirements set by each lender, as multiple financing options are available. Educate yourself on the lending process to choose the option that best fits your needs.

How small business loans work

Taking out a small business loan involves borrowing money to develop or extend your business. You’ll typically have to repay the loan amount along with interest and fees within a predetermined period.

You can choose between a secured or unsecured loan. If you opt for a secured loan, you’ll need to provide collateral that the lender can take possession of if you fail to make loan payments. Collateral can be in the form of equipment, real estate or money. On the other hand, unsecured loans may require a personal guarantee wherein you and other business owners take responsibility for paying back the loan.

Types of small business loans

There are many loan options available to small businesses from different sources, including online lenders, large banks, credit unions, and peer-to-peer lending sites. Each of these sources provides different types of loans to choose from.

There are various types of business loans that differ in terms of loan amounts, interest rates, fees, eligibility criteria, possible uses, and repayment terms.

  • Term loans: Term loans are a type of loan where a fixed amount of money is borrowed and then repaid within a specific time period, usually spanning from two to five years.
  • SBA loans: Loans supported by the U.S. Small Business Administration are recognized for their extended repayment periods and low-interest rates. However, they require more time for application and qualification.
  • Business lines of credit: Business owners have the flexibility to borrow within their limit as much or as little as they need with business lines of credit. Secured and unsecured lines of credit are both available.
  • Equipment loans: Equipment loans are meant for purchasing new or used equipment, which will serve as the security for the loan.
  • Invoice factoring: Invoice factoring means you sell your unpaid invoices to a third party and receive payment for a fee.
  • Invoice financing: Invoice financing and invoice factoring have similarities, but invoice financing entails selling unpaid invoices to a lender. Upon doing so, the lender pays the business an advance of the invoice’s value. Once the invoice is paid, the business remits a small fee to the lender.
  • Commercial real estate loans: Real estate loans are meant to be used for buying or renting commercial property, and this property serves as security for the loan.
  • Microloans: Microloans are small loans for businesses with low annual revenue, typically under $50,000, that can be issued privately or by the SBA. These loans usually require a personal guarantee and collateral as security.
  • Merchant cash advance: This refers to a loan where a fixed amount of money is provided and is paid back using a percentage of future credit card sales. Typically, these loans have higher APRs or factor rates than other business loans.
  • Franchise loans: Franchise loans are designed specifically for purchasing or expanding a franchise.

How to qualify for a small business loan

Qualifying for a small business loan will vary based on factors like the lender, loan amount, and type. However, many small business loans have similar requirements.

  • Credit score: Most lenders will check your credit to get approved for a loan. It’s suggested that you have a personal FICO score of 600 or more, but some lenders may accept scores as low as 500. They may also require your business credit score.
  • Cash flow: Make sure you are ready to provide your bank statements and tax returns for your business.
  • Earnings: Most lenders require a minimum annual revenue of at least $100,000.
  • Time in business: Most banks require businesses to have been operating for at least two years, while nontraditional lenders may accept businesses that have been operating for only six months. Startups may also be able to find lenders, but they could face higher interest rates or stricter requirements in other areas.
  • Debt load: To increase your chances of getting approved for new loans, it is important to maintain a good debt-to-income ratio that shows your business’s ability to repay additional debts. If your business has too much debt, it can be challenging to secure new loans.
  • Security: To secure the loan, most lenders may ask for collateral such as real estate, equipment, cash, or a blanket lien on the business.
  • Industry: Lenders may be hesitant to loan money to businesses in certain industries that are considered high-risk, such as food service or those related to gambling, weapons, cryptocurrency, and marijuana. This is because they want to minimize their risks.

It is recommended to research a lender before applying to determine if your business meets their requirements.

The bottom line

There are several loan options available from various sources for small businesses. These loans work just like any other loan, where you apply for the loan, receive funding upon approval, and work towards repaying the loan on a predetermined schedule.

If you’re a new business owner looking to grow, consider exploring various lenders such as online lenders, large banks, and peer-to-peer lending sites. Given the wide range of loan programs available, it is important to carefully research the requirements and interest rates of each before applying for the loan that best fits your needs.

More articles

Latest article