Business Banking

What is a business loan?

What is a business loan, and how do they work? Learn everything you need to know before speaking to a loan advisor.

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Whether you’re planning on owning a business in the future, working with a startup, or growing your current one, chances are you’ll need some financial support to achieve your goals if you don’t have enough money in your bank account. This is because all companies require capital to fund their operation or establish themselves. Luckily, there are several business loan options available for small business owners and entrepreneurs to choose from.

However, you may be wondering, what is a small business loan? And how do they differ from other loans available? Therefore, today we are going to go over the fundamental aspects of business loans, so you can make wise, informed decisions for your business. For more information, keep reading.

What is a business loan?

A business loan is a form of lending agreement established between a business and its bank or a private lending firm. And like all loans, the lender provides financial support under a contract to a business or entrepreneur that is to be paid back within an agreed-upon time frame and interest rate. With this this loan, companies are able to use their financial advancement for various purposes, such as:

  • Renovations to improve their business location
  • Technological enhancements such as new company computers and software
  • Purchasing real estate
  • Paying employees
  • Business acquisitions

Similar to other financial advances, once you have been approved for your business loan, you will be required to make regular payments. However, the interest rate you pay, and the repayment terms will vary depending on who you borrow money from and your prerequisites as a borrower.

What is an example of a business loan?

Say you want to expand your business by opening up another location. However, while business is good, it is not enough to afford to purchase a new place. Therefore, rather than taking out a second mortgage under your name, you can approach a lender and apply for a business loan with the purpose of purchasing a new real estate down payment under your company.

Thus, while this loan belongs to you, you can still protect your personal finances by applying for a business loan, depending on what your needs and requirements are.

How do business loans work by type?

Furthermore, you may be wondering, “how do business loans work?” And as we mentioned, regardless of why you may need to borrow money, there are several different types of business loan options available. Therefore, we are going to be diving deeper into some of the types, so you can have a better idea about which one may be right for you and your business endeavor.

1.    SBA Loans

SBA loans are a category of business loans that are assured by the U.S. Small Business Administration (SBA). With interest rates ranging from approximately 2.8% to 13%, this government-funded loan is an affordable option for securing financing for your business. However, the application process can take several weeks, and you may be subjected to sizable borrowing conditions. In addition, the government also requires you to have a credit score of at least 680 to qualify.

Furthermore, the most popular forms of SBA loans are:

  • SBA Microloans: This type of SBA loan helps businesses meet their capital needs. It can also help you purchase supplies and equipment. Typically, these loans offer you up to a maximum of $50,000.
  • SBA 7(a) Loans: These loans are suitable for business owners who wish to acquire another business, expand their current company, or secure working capital. Accordingly, you can expect up to $5 million in loans.
  • SBA 504 Loans: For businesses looking to purchase real estate or update their current business property, these loans also allow you to borrow a maximum of $5 million.

2.    Term Loans

Moreover, a term loan is a traditional bank loan that you would borrow from a bank, online lenders, or a credit union. If approved, business owners are required to pay back their loan over a fixed period with a fixed interest rate. Both of which will be determined by the lender you borrow money from. Additionally, the amount of funds you are able to borrow will also vary, depending on who you choose to borrow money from.

Further, while term loans are suitable for business owners with good credit scores, you may be required to make a legal agreement and provide personal collateral should your business fail in the future.

3.    Business Line of Credit

The next type of business loan available is a line of credit. A business line of credit provides you with the flexibility of only paying interest on a portion of the total amount of money you borrow –similar to a credit card. Therefore, you are able to borrow money from your line of credit when needed and repay the borrowed amount of money when you can.

However, keep in mind that you will not be able to exceed your credit limit. Accordingly, this is a good option for businesses looking to direct their flow of money or purchase supplies for the company.

4.    Short-Term Loans

Moreover, a short-term loan, also known as a business term loan, is a type of lump-sum payment provided to businesses. Once you have been approved for a short-term loan, you will be required to make fixed, regular payments at a fixed interest rate.

Generally speaking, short-term business loans require repayment within one to five years. However, they are good if you need to finance a large purchase.

5.    Merchant Cash Advance

Another type of business loan programs available is also known as a merchant cash advance. Although a cash advance is not exactly a loan, it still provides you with funding quickly, should you require it. With a merchant cash advance, you are able to receive cash upfront in exchange for a portion of your business's future debit or credit sales.

However, keep in mind that these types of advances come with high-interest rates and are determined by your ability to pay back your advances quickly. On the other hand, you will not need to offer personal collateral when applying for a merchant cash advance because they are considered unsecured. In addition, your required payments will vary depending on how successful your business is.    

What are the advantages of a business loan?

Furthermore, now that you understand the question, “what is a business loan?” and what the different types are, let's look at some of the advantages to applying for these types of loans below.

1.     Business loans are flexible. Therefore, you can apply for one that meets your requirements so that you can reach your business goals.

2.     Increased business budgets. With more funding, you can expand your budgeting requirements for your business. So, you can realistically spend more money on marketing and promotions to grow your business to a larger target audience.

3.     Most business loans are liability-free. This means that you will not have to commit any personal collateral or possess a specific income requirement before applying.

4.     You can shop around for affordable interest rates. As there are so many business loans available, as well as banks and credit unions, you have the ability to shop around for the best interest rate according to your needs.

5.     The interest rate is eligible for tax deductions. Therefore, you will not have to pay taxes on profit portions that come from your small business loan.

6.     You can boost your business credit. By taking out a loan for your business, you will be able to increase your business credit. This ultimately grows your business cash flow over time.

7.     You do not need to share profits. Unlike searching for an investor for your business, taking out a business loan does not require you to share any profits you make from the money you borrow, no matter how successful your business does.

However, while there are many advantages to obtaining a business loan, keep in mind that loaners will not provide these types of loans to just anyone. As a result, there are often strict eligibility requirements. Some of these qualifications include:

  • How long you have been in business, if applicable.
  • Your personal credit score, along with the credit score of your business.
  • The annual or monthly revenue your business collects.
  • Bank statements from your company.
  • Records for your personal tax returns, along with the tax returns from your business.
  • A personal background check and credit report.
  • Proof of a business plan, along with your business projections.
  • Any legal documents such as your license to operate, any agreement documents, your property lease, and more.

While not an exhaustive list of qualifications, there is nothing wrong with organizing your documents before meeting with credit unions or banks to streamline your business loan process.

Business loan repayment

So, when do you start paying back a business loan? And the answer to this question is around 30 days after you have received your money. However, similar to any loan you apply for, there will be associated repayment requirements you must follow. However, these terms will vary depending on who you choose to loan money from and the type of business loan you select. Nonetheless, there are three types of loan repayment options available. Here is a closer look at each one.  

1.    Revolving

A business credit card or credit line of payment are two types of loans that have revolving payments. This means that when you get your business loan, you will be given an account that allows you to borrow money when you want. The amount of money you take out will reduce your available credit. However, your available credit will increase once you pay it back.

2.    Installment

Furthermore, the next type of repayment option available is known as an installment. An installment loan provides you with the entirety of your loan amount upfront. You are then required to make equal monthly installments to pay it back over a fixed period of time. Furthermore, this form of repayment option is what is typically used for most business loans.

3.    Cash Flow

The final type of repayment option available is cash flow repayment. This repayment option is similar to an installment loan as you receive the total loan amount upfront. However, you do not pay back the loan in equal installments on a monthly basis. Instead, your repayment is directly linked to the amount of cash flow your business receives.

Do you have to pay back a business loan?

Moreover, while you are required to pay back a business loan, you may find yourself unable to make a payment. Therefore, keep in mind that lenders aren’t typically fond of surprises. So, should this occur, the best thing to do is inform your lender as soon as possible. Depending on who you borrow money from, you may be able to partially pay your monthly payments or extend its due date.

However, if you are unable to come to an agreement with your lender, you may be required to seize your collateral if you have a secured business loan. On the other hand, unsecured business loans do not require collateral.

How to choose the right loan for your business

Lastly, to choose the right loan for your business, you need to first evaluate what your current needs are. Here are some of the factors you need to consider before approaching a lender to submit your loan application.

  • How much money will you need?
  • What are your business needs?
  • What business expenses do you have?
  • How long have you been in business?
  • How long do you expect it will take you to pay back your loan?
  • How are your current business finances?
  • What is your annual revenue?
  • Do you have a bad credit score and credit history? What about your business credit score?
  • Do you have any other loans under your name?
  • What kind of collateral do you have?

Once you have been able to answer these questions, you will be able to have a better idea about what kind of loan is right for you. When in doubt, if you need financial advice, book an appointment with your financial advisor at your financial institution for more guidance on qualifying and financing options.

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