Business Banking

What you need to know about guaranteed business loans

Ever wondered what a Guaranteed Business Loan is and if it’s right for your business? Our article goes over the details and how it relates to small business owners.

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A guaranteed business loan is a type of loan that is backed by a third party, usually called guarantor. As the business owner, you (and your business) are the borrower. If you default on the loan, the guarantor is legally responsible for paying it back.

A guarantor’s backing can either be limited or unlimited. An unlimited guarantee means that the guarantor will pay back the loan in full if you default on it. On the other hand, a limited guarantee means that the guarantor only covers part of the loan. For example, SBA loans have an unlimited guarantee because the federal government only backs them up to a maximum of 85%.

Loan guarantors can be individuals, companies or government organizations. In fact, your company’s own invoices and accounts receivables can act as a guarantee for a loan. Oftentimes offering this kind of security minimizes risk on the lender’s part. This, in turn, incentivizes them to grant your business the loan.

Some lenders usually go a step further to offer better lending terms and lower interest rates. That’s because they have some level of assurance that they’ll get back their money. This is what makes guaranteed loans quite attractive to some small business owners.

However, before you commit to any guaranteed loan, you’ll want to choose a type that matches your business needs. This article breaks down the various types of guaranteed business loans and how you can qualify for each.

Key takeaways

  • A guaranteed business loan is a type of loan where a third-party pledges to pay back the debt in full or in part if the borrower defaults.
  • There are five main types of loan guarantees, namely, personal guarantee, corporate guarantee, validity guarantee, federal guarantee and bank guarantee.
  • Personal and federal guarantees are the most common for small businesses, although validity guarantees are also options when invoice financing is involved.
  • To apply for a guaranteed loan, start by finding a lender, collect your documents, and finally complete the application.

Types of guarantees in business loans

When it comes to small business loans, there are five common types of guarantees.

Personal guarantee: this is a promise made by an individual to repay a loan taken out by a business should that business default. The individual may also pledge their assets to cover the defaulted loan. As the business owner, a lender may ask you to offer a personal guarantee on your company’s loans. This essentially means that you’ll be liable for the loan if your company fails to repay it. While other people can guarantee a loan for a business that you own, the Federal Reserve Regulation B prohibits lenders from requiring spousal guarantee1.

Corporate guarantee: this is a promise made by one company to cover the loan of a second company in case that second company fails to repay the loan. For example, as a small business owner, you may request another small business to guarantee your business loan or line of credit. Under this agreement, if your company fails to pay the loan, that other business will pick up the responsibility. Of course, not all companies will accept a corporate guarantee because of the risks involved.

Validity guarantee: typically used by factoring companies, this type of loan guarantee basically involves you pledging to turn over valid invoices to your lender in an invoice financing agreement. One good thing about a validity guarantee is that you won’t need to tie your personal assets to the agreement. Therefore, if your customers default on their payments, you won’t necessarily lose any personal property.

Federal guarantee: this is a guarantee offered by the federal government to lenders who provide small business loans. By backing these loans, the government offers security and allows private lenders to approve loans requested by small business owners. A good example of a federal-backed loan is the SBA loan guarantee program. The government gives financial institutions a limited guarantee of up to 85%.

Bank guarantee: a bank guarantee is a promise made by a bank to cover a business’s debts should that business fail to meet its payment obligations. Banks typically provide this guarantee as a form of security to companies that are trading with foreigners or unfamiliar parties.

In some cases, the guarantee may come from a non-bank institution like an insurance company. This is usually called a financial agreement. Under such an agreement, the insurer pledges to repay the debts of a business in case it fails to do itself. This too offers security to individuals and companies that are offering credit-oriented contracts to the said business.

Types of guaranteed business loans

The two most common types of guaranteed business loans are SBA-guaranteed loans and personal-guaranteed loans. These two differ in the sense that SBA-guaranteed loans are backed by the federal government while personally guaranteed loans are backed by individuals – typically the business owner. Below is a detailed look at the types of guaranteed business loans.

SBA-guaranteed business loans

These are loans that are backed by the U.S. Small Business Administration and issued by private lenders. They include term loans, lines of credit and microloans that support over 61,000 small businesses with loans2.

SBA loan programs allow you to borrow money for various business uses, such as working capital and real estate purchases. The federal government guarantees loans up to 85% for amounts under $150,000 and 75% for amounts exceeding $150,000. With their low interest rates and longer repayment terms, SBA loans can be lifesavers to small business owners who are looking for affordable financing.

Something to keep in mind is that there are various types of SBA-guaranteed loans. Each type is meant for particular business uses. For example, while the SBA 504 provides money for real estate and asset financing, the SBA microloan offers a short-term working capital loan. Therefore, knowing your business needs will help you find an SBA-backed loan that can meet those needs. Below are the most common types of SBA loans.

  1. SBA 7 (a) loan

With a maximum loan amount of $5 million, the SBA 7 (a) can be used for a variety of business purposes. That’s one of the reasons why it’s the most popular SBA loan program, accounting for over $36.5 billion of small business financing2. Here are some of the things that you can do with an SBA 7 (a) loan:

  • Purchase of commercial estate like land and buildings
  • Purchase of equipment, machinery, furniture, fixtures, supplies or materials
  • Renovating existing spaces and construction of new buildings
  • Buying an existing business or establishing a startup
  • Filling short- and long-term working capital gaps
  • Refinancing current business debts under certain conditions

Repayment terms of SBA 7 loans depend on how you use the loan proceeds. For example, if you use it for real estate, then you can repay over a 25-year term. Equipment financing loans have a maturity period of up to 10 years as long as the equipment stays useful during that time. In relation to working capital, the loan term is usually up to 7 years.

As for interest rates, your lender determines what to offer either in fixed or variable rate. However, the current SBA 7 (a) interest rates range from 7% to 9.5%. The SBA may also charge a guarantee fee, which lenders typically pass on to borrowers. So, expect that as well. It can range from 0% for loans under $ 150,000 to 3.5% on loans of more than $700,000.

  1. SBA 504/CDC loan

This loan program provides long-term fixed rate financing to small businesses. The SBA 504/CDC loan amount maxes out at $5.5 million but you can qualify for up to $20 million. That’s because this loan program actually has three different contributors: your lender, a Certified Development Company (CDC), and you (the borrower) who provides a down payment. So, while the federal guarantee may end at $5.5 million, your down payment and the CDC’s contribution can push the loan amount higher.

The SBA 504 has a maximum repayment term of 25 years. It is primarily a commercial real estate loan. As such, you can use the loan proceeds for:

  • Purchasing owner-occupied commercial real estate
  • Construction or renovation of commercial property
  • Acquiring fixed assets

SBA 504 interest rates vary from lender to lender, but they can dip as low as 4%. Generally, the longer the loan term, the lower the interest rate. Your personal and business credit profiles will also play a role in determining your overall interest rate. For example, if you have a good credit score and your company generates sufficient revenue (which is subjective depending on the lender), you may get a low interest rate. On the other hand, a bad credit profile will likely make the lender charge a higher interest rate.

  1. SBA Microloan Program

Business owners with smaller funding needs can benefit from SBA microloans. Typically, under this program, the SBA partners with nonprofit community-based organizations to serve as intermediaries. These institutions then create microloans and lend them to eligible small business borrowers. Some microloan lenders go beyond financing by offering financial counseling, assistance in securing government contracts and general business management skills.

SBA microloans have a maximum amount of $50,000, but the average approved amount is about $13,000. Because of this smaller loan amount, a microloan is ideal for short-term working capital needs like buying inventory. But you can also use the funds to purchase low-cost machinery, supplies, fixtures etc. However, you can’t use an SBA microloan to purchase real estate or repay an existing debt. Thus, it’s not the best financing option for things like debt refinancing and consolidation.

Interest rates charged on SBA microloans vary from lender to lender. However, they normally range from 8% to 13%. The loans have a maximum repayment period of six years. 

Personally guaranteed business loans

Under a personal guarantee, you as the business owner pledge to repay the lender if your business defaults on a loan. The lender gets a legal right to seize your personal assets if your company defaults on payments.

It’s not uncommon for lenders to ask for a personal guarantee when you’re taking out a credit facility. This applies to many different types of business loans, including term loans and lines of credit.

Guaranteed business loan requirements

Qualifying for guaranteed business loans depends on the lender and type of loan. Many of them will look at your personal and business creditworthiness during underwriting. This is where credit score, income, debt-to-income ratio and other underwriting factors come into play.

That said, there are some standard eligibility requirements for all types of SBA loans:

  • Your business must be a small business as defined by the SBA.
  • It should be located and operated in the U.S. or its territories.
  • The business should be a for-profit company operating in an eligible industry.
  • As the business owner, you must have invested your time and money in the company before seeking for the SBA’s assistance.
  • You must have tried and exhausted all other sources of business financing before applying for an SBA loan.
  • The business must be able to show that it needs additional capital.
  • You must not have previously defaulted on a federally guaranteed loan.
  • In case of shared ownership, no single owner with a 20% or more stake should be currently incarcerated, on trial, on probation or on parole for a criminal case.

In addition to the above, individual lenders will set their own eligibility requirements before approving guaranteed business loans. These will mostly revolve around income, creditworthiness and time in business.

Personal credit score requirements

A strong credit score is essential when applying for a guaranteed loan, especially if it’s backed by the SBA. That’s because SBA loans are highly competitive, and lenders prefer borrowers with a history of diligence in repaying debts. Any FICO score above 690 puts you in a good place, but ideally you should be aiming for at least 720.

The same applies for personally guaranteed loans. Traditional banks and credit unions are especially strict when it comes to credit score. Many require at least 680. But online and alternative lenders don’t always require a strong credit profile, more so if you can offer a personal guarantee. This makes them viable loan options for small business entrepreneurs with bad credit.

Business credit score requirements

If you have registered your business with credit bureaus, then it likely has its own credit history and credit report. Lenders may pull this report during underwriting. Many SBA loan providers typically use the FICO SBSS system. Again, a strong business credit report will make a solid case for you. Ideally, you’ll want your business to have a score of at least 155.

In case you haven’t had enough time to build business credit, or perhaps you’ve never registered your business with credit bureaus, you can consider applying for loans from alternative and online lenders. Some of them do not have credit score requirements.

Annual revenue

An annual revenue of at least $100,000 is typical, but your lender may require more or less. Regardless, many loan providers usually request for income tax returns and business bank statements to check how much your company generates. This will tell them whether or not it makes enough money to meet the monthly payments that come with a guaranteed loan.

Time in business

A business that has been in operation for longer is deemed less risky by lenders. On the other hand, startups and newly acquired businesses are perceived as riskier. For this reason, many lenders prefer at least two years in business before they can approve your SBA or personally guaranteed loan.

Online lenders typically require a shorter time in business – six months to one year. Some may approve your loan application even if you’re setting up a startup. Therefore, if your business is new, consider shopping for online and alternative loans if traditional financing seems hard to get.

Debt-to-income ratio

Also known as DTI, this ratio shows how much of your revenue goes into paying existing debts. You can calculate it by dividing your monthly debt by gross revenue. If your DTI is high, it means that your income can barely sustain your current debts. Therefore, taking up a new debt – whether it’s SBA-backed or personally guaranteed – may not be a good idea.

Lenders may approve your loan application if you have a debt-to-income ratio of 43%. However, many prefer it to be 36% or lower. Such a low ratio shows that you still have enough cash to take on the responsibility of a new loan.

Debt-service coverage ratio

Usually abbreviated as DSCR, your debt-service coverage ratio shows your company’s ability to make debt payments on time. You can calculate it by dividing net operating income by debt service. The higher the value, the better prepared your company is at paying debts.

If it’s less than one, then it means the business doesn’t have enough current assets to pay debts. In other words, it’s operating with a negative working capital. Lenders will likely not approve you for a loan if your DSCR is less than 1.15.

How to apply for a guaranteed business loan

Step 1: Find a lender

Whether it’s federally backed or personally guaranteed, the first step to getting a loan is finding a good lender. Ideally, you want a lender who offers low interest rates. Therefore, make sure to compare rates (and lending terms) before settling on one lender. Personally guaranteed loans are typically available from traditional, online and alternative lenders.

For SBA loans, you will want to work with banks, credit unions and online lenders who are SBA-approved. If you have no idea where to start, talk to the bank you have a relationship with and ask them whether they offer SBA loans. You can also use the SBA’s Lender Match, which essentially searches for lenders who can offer the type of financing you need.

In the case of SBA 504 loans, you can only get the facility through a Certified Development Company (CDC). If your SBA-approved financial institution can’t point you to a CDC, you can try visiting your local SBA office to discover the CDCs that exist in your area. This organization will process your application, assist in coordinating your financing and submitting the loan application to the SBA.

And if you’re going for an SBA microloan, you will need to find an SBA approved intermediary within your area. These are essentially nonprofit organizations that create microloans. The SBA then guarantees the loans. Therefore, you first have to find an SBA approved intermediary within your area. The SBA also has a list of intermediary lenders on its website that you can go through to ease your search.

Step 2: Put together documentation

Collect all the documentation that is required by the lender. If you’ve already found a preferred loan provider, chances are they’ll tell you every document that’s needed beforehand. It can be a bit time consuming and tasking but ensure you have everything needed in the application process.

These documents vary from lender to lender and depending on the type of loan. If you’re applying for an SBA guaranteed loan, you may be required to submit SBA-specific forms. Some documents that you may be required to provide include:

SBA forms:

  • Borrower Information Form: Form 1919
  • Statement of Personal History Form: Form 912
  • Personal Financial Statement: Form 413
  • Unlimited/Limited Personal Guarantee: Form 148 or 148L

Business financial statements:

  • Profit and Loss Statements for the past three years
  • Projected Financial Statements for the next one year
  • Balance sheet
  • Statement of cash flow
  • Business income tax returns
  • Personal tax returns
  • Business leases and important contracts

Basic business information:

  • Ownership, affiliations and structure
  • Overview and history of business
  • Business certificates and licenses
  • Resumes of business owners and top management
  • Business plan

As mentioned, the exact documentation will vary from lender to lender and depending on the type of loan. For example, SBA 504/CDC loans typically require contractor estimates when construction is involved. Similarly, you may be asked to provide recent pay stubs when applying for an SBA microloan. Make sure to work closely with your lender so that you know the types of documents needed during the application process.

Step 3: Complete and submit your application

Fill and submit your loan application forms. Online lenders will allow you to complete the entire process over the internet, regardless of the type of loan. More traditional lenders – like banks and credit unions – often require in-person applications for certain types of loans.

For example, Bank of America requires that all applicants complete SBA 7 and SBA 504 loan applications in person or over the phone. However, they may allow you to do everything online if it’s a personally guaranteed loan.

Whatever the case, the exact process will depend on the lender. Personally guaranteed loans generally take a shorter time for the proceeds to reach your business bank account. Some online lenders approve loans within hours and wire funds in the next one or few business days. But that’s not always the case with SBA loans. These typically take 60 to 90 days to apply for and get the proceeds in your bank account.

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