Are you trying to figure out how to get the money you need? Read this article to learn the answer to the question “how do business loans work?”
Whether you’re thinking about becoming an entrepreneur or an existing business owner, every enterprise needs a little jump start in terms of funding.
When it comes to running a successful business, there’s no shame in asking for help. Business startup costs are significant, and if you want to do it right, asking for help can get you ahead.
Related Post: How Can the SBA Help Your Struggling Business
So, how do business loans work? Learn all about loan variations, repayment terms, and qualifications in this blog.
How Do Business Loans Work? Understanding the Basics
Loans of any type require routine payments, based on a set schedule. However, loan interest rates and payment terms vary greatly depending on the type of loan.
There is a myriad of business loans on the market to suit all sorts of business owners and their needs. Just some of the most popular and accessible loans include:
1. Small Business Administration Loans
Commonly referred to as SBA loans, they are partially insured by the U.S. Small Business Administration. These types of loans suit various startup needs. This includes real estate purchasing, business expansion, working capital funding, and more.
In order to qualify for an SBA loan, you must meet a strict set of criteria. It may take a while to get approved and receive funding, but SBA loans tend to offer the lowest interest rates.
2. Term Loans
These types of loans are based on a very specific time period. In short, you can choose between short-term, intermediate, or long-term loan periods.
Intermediate and long-term loans are traditional bank loans and require your business to have a solid footing of at least two years’ in operation. They offer lower interest rates, compared to shorter-term loans. You usually get five-10 years to pay off these types of loans.
Short-term loans are ideal for new businesses that are looking to get off the ground. However, interest rates are higher, and the loan must generally be repaid within a year.
3. Line of Credit
A business line of credit is based on a revolving credit line with a lender. Repayment terms are divided into two phases: the draw and repayment periods.
The draw period allows you to use as much available credit as you need, repay it, and then use it again. During the draw period, you only need to make interest-based payments.
The repayment period is simple: you need to pay off whatever you owe on your current balance remaining from the draw period. You will no longer be able to draw funds during this time.
Business lines of credit require a solid foundation as well as a few years of business operation. However, some lenders are willing to work with startups that show good potential.
4. A Merchant Cash Advance
If you’re looking for money in a hurry, a merchant cash advance can be very useful. But precaution is necessary. Interest rates are generally very high.
This type of loan allows for a cash advance based on future revenue you intend to make i.e. merchant debit or credit card sales.
The repayment terms are based on a percentage of your predicted sales, rather than set installments, like other loans.
There are numerous other lines of credit available to small and existing businesses, including:
- Business credit cards
- Trade credit
- Invoice financing
- Equipment financing
Ultimately, it’s up to you to do your research on loan terms and whether your business can realistically afford repayment and interest rates.
Business Loan Repayment
Depending on the type of loan you apply for, repayment terms will vary. There are three distinct forms of repayment:
- Revolving—this is based on the same principle as a revolving line of credit, also used for business credit cards
- Loan installment—you will receive the full amount of the loan upfront, but must pay it back in fixed, monthly installments
- Cash flow—you also receive the full loan amount upfront in cash and repayment is based on your business cash flow, rather than a fixed installment
Carefully consider which repayment terms suit your business. Defaulting on a business loan can damage your overall credit score and any possibility of applying for a loan in the future, too.
How Do You Qualify For a Business Loan?
While there are numerous loan types available to business owners, the process of applying is pretty much the same for each. You’ll generally need to meet the same set of criteria in order to qualify for most loans.
Also Read: How to register a startup/business in UK?
Here’s how your business will be assessed:
1. Business and Personal Credit Rating
First thing’s first, your business will be judged on its existing credit score. If your business is registered in your name, your personal credit score will also be closely assessed.
If your business is already well-established, lenders will run a credit check to identify how your business has been managed. Ultimately, poorly managed finances and a poor credit score can make loan qualification near impossible.
2. A Review of Credit Reports
A credit score is more like a general indicator of how well you manage your debt. But, it doesn’t paint a full or clear picture. This is why lenders will also do a background check on your credit reports.
Basically, they are looking for any concerning tradelines. This includes previous instances of foreclosure, bankruptcy, missed loan repayments, etc.
3. Length of Business Operation
It’s no secret that starting your own business is risky, with plenty of potential for failure. In this case, many business lenders are wary to loan to startups without a few good years of operation under their belt.
Generally, your business will need a minimum of two years’ operation to qualify for SBA loans, lines of credit, and term loans. However, very new startups can obtain merchant cash loans, trade credit, and financing.
Also Read: 20 Steps to Launch Your Own Startup
4. A Review of Business Finances and Collateral
Naturally, lenders require detailed reports on your business financials in order to gauge how your business performs on a monthly basis. This includes cash flow statements, profit and loss numbers, balance sheets, and financial projections.
They assess how strong your business looks financially, then make a decision based on your ability to repay a loan.
Lenders will also look at business collateral, especially those that offer lower interest rates on loans. If you default on a loan, what can they use as collateral to make up for the defaulted payments?
Your business collateral, such as real estate or business equipment will be closely assessed.
Learn How to Launch Your Dream Business
Whether you apply for term loans, SBA loans, or revolving credit, do your homework and finances, first. Be realistic about what you can afford and how a loan could really benefit your business.
If you’re looking for advice on entrepreneurship, startups, technology, marketing, and more, explore this site and put your business plan to work!