If you have a business, it is expected that you will need to apply for a loan from financial institutions at some point. As you already know, the company needs to have adequate money to fund various expenses.
Business Loans Explained
Generally, a business loan is a lending agreement between banks or private lenders and business owners. Companies need capital to fund business operations or start something and begin generating a profit. Lenders today are willing to disburse money to these businesses, given that they repay the loan on schedule.
The purpose of business loans explained
When applying for a business loan, some lenders will ask the borrowers their purpose for using it. Additionally, the loan’s purpose is one thing lenders will look into in approving business loans.
- Expansion. A company is expected to expand at some point in its corporate journey. But growth can be costly. In most cases, using the cash flow and daily sales revenue will not suffice. Hence, they turn to business loans for funding. There are various types of loans companies can get depending on their specific needs.
- Inventory. Seasonal businesses need to ensure available stock even during the off-season. When it is off-season, companies can expect lesser sales output. Consequently, they may have a hard time filling the inventory. So to avoid hurting their cash flow, a business loan can cover inventory purchases until the business goes into full swing during the peak season.
- Equipment purchase. Purchases of machinery and other equipment could mean that older equipment needs replacement. Additionally, some businesses might need to improve their operations through advanced equipment. The same with expansion; machinery is costly. Even the cash flow cannot cover its cost. There are business loans that specifically cater to equipment purchases. The equipment itself will serve as collateral for the loan.
- Cash flow. On slower days, sales can be tight. Along the way, it can eventually affect the company’s cash flow. Lenders can provide business loans to companies to fill in the cash flow gap and ensure consistency. As you already know, a steady cash flow can increase the probability of businesses getting better loans.
- Promotion and marketing initiatives. Expanding the business also means more marketing campaigns to do to introduce the products to new markets. Campaigns can range from simple ones like posters and flyers. They can also be extravagant, like TV and radio commercials. If this happens, you will need to source considerable money to fund the campaigns.
Kinds of business loans
Companies can take advantage of a huge selection of business loans. Here are some of them.
- SBA loans. This is a type of loan which is guaranteed by the United States Small Business Administration (SBA). The loan reduces the risks for lenders if the borrower defaults on the loan. Generally, the federal government will guarantee to repay 85% of the loan amount if the borrowers default. There are three kinds of SBA loans: SBA 7(a), SBA 504, and SBA microloans. Additionally, the interest rates can range between 2.8% and 13%.
- Term loans. When people search for small business loan options, they will first find term loans. Technically, businesses borrow money from traditional banks, online lenders, or credit unions. They will then repay the loan over a fixed period. In most cases, these loans also have fixed interest rates.
- Short-term loans. A short-term business loan refers to those with terms under three years. Suppose you need quick cash for your business; a short-term loan can be an ideal option. Companies can get the funding as fast as one day.
- A business line of credit. A line of credit is another kind of business financing where lenders provide cash on an as-needed basis. To simplify, they work like credit cards where the borrower gets funding up to a specific amount. The interest will depend only on the amount borrowed and not the entire principal. In most cases, lenders allow borrowers to use the line for 12 to 24 months. Suppose you are wondering how business loan repayment works under lines of credit; it usually lasts up to five years.
- Start-up loans. You already know that the lender will look into the age of your business before they approve the loan. For start-ups, it can be difficult to secure business loans. However, some lenders cater to these types of businesses. Start-up business loans can be SBA microloans, business credit cards, or online loans.
- Microloans. As the name suggests, a microloan features smaller loan amounts and shorter repayment terms. Also, the interest rates are relatively low. In some cases, there are no interest rates involved. Qualified businesses can loan up to $50 000. If your business only needs smaller loans, then microloans might be for you.
- Invoice factoring. This type of loan involves selling unpaid invoices to a factoring company. The company will then give your business an advance of around 70% to 95% of the total invoice value upfront. Then, the factoring company will be responsible for collecting the invoice payments from your customers.
- Invoice financing. This still involves invoices. But instead of the factoring company collecting the payments for the unpaid invoices, your business will be the one to do so. The invoices will serve as collateral to secure the cash advance. The advance is usually up to 80% of the total value of the unpaid invoices.
- Merchant cash advance (MCA). An MCA is another business loan where the repayments rely on future credit card sales. Similar to other loans, the borrower gets a lump sum of cash. The lender will then take out a percentage of your sales as repayment. In most cases, repayments happen daily. The factor rates in MCAs usually play around 1.2 to 1.5.
- Equipment financing. This type of loan is particular and designed to cater to companies planning to buy equipment or machinery. The equipment will then serve as collateral to secure the loan. When a borrower defaults, the lender can assume ownership and resell the equipment. Since there’s collateral involved, borrowers can typically get competitive interest rates through equipment financing.
- Working capital loans. This is another short-term business loan that can work with seasonal businesses and those that need access to capital until the sales revenue gets back up in the future. Online lenders like New York Tribeca Group provide options for businesses looking for working capital.
- Commercial real estate loans. Similar to equipment loans, a commercial real estate loan allows businesses to get funding to purchase real estate properties. In return, the property will serve as collateral. When the borrower defaults on the loan, the lender can foreclose the deal and sell the property to another business or individual. This is their way of recovering at least a part of their investment.
- Personal loans. In some cases, business owners might use a personal loan to get funding for business expenses. However, not all lenders accommodate this type of loan. Small businesses might consider this option as the approval will depend on the personal credit score instead of the business credit. As you may know, some small businesses have yet to establish their credit profile; hence it can be challenging to get business loans.
How does business loan repayment work?
Repayments will depend on various factors, including the lender. Suppose you are wondering how business loan repayment works; it can be handy to talk with your lender. This way, they explain thoroughly how the repayments will go, how long you need to pay for the loan, and how often you need to make payments.
Additionally, this is one of the more essential things you must clarify before committing to the loan. To avoid missing repayment schedules that might affect your credit score, it pays to be familiar with how they are done. Also, besides the schedule and amount, it is essential to know the frequency of your payment. Some lenders impose daily, weekly, or monthly payment schedules.
Qualifications to get a business loan
Even if the loan application is straightforward, you can never assure that you will always get the nod from lenders. Hence, one needs to know some points before applying for a loan.
- Ensure that you have a good credit score. While not all, there are business loans where lenders need to look closely at one’s credit score before they approve the loan. In most cases, your score lets lenders know how you performed with your previous loans. Additionally, they can assess whether you are an excellent payor or not. Besides that, the credit score will also determine whether you will expect higher interest rates. As you may know, lower credit scores might mean a much higher interest.
- You must have an established credit history. This is also a case-to-case basis since there are lenders who accommodate start-up loans that do not have an established credit history. But if your business plans to take out term loans, it can be beneficial to prepare documents proving that you have been in the business for years. More importantly, the document will also show your payment behaviors.
- Sales are important. Some loans heavily rely on credit card sales, like merchant cash advances. In this case, you need to provide the lender with proof that your business can generate good sales enough to settle the repayments. Also, excellent business sales will tell lenders about the business’s health. So if sales are bad, it can be a red flag to lenders. They might see it as one of the reasons why they might reject your application.
- Provide your business history if necessary. Most lenders would want to understand your business besides evaluating your payment behaviors. The document containing your business history is essential for some lenders as they might be able to offer you more loan options besides the one you are applying for. Also, lenders will immediately approve loans from businesses operating for at least two years.
Business Loans Explained FAQs
Can businesses with poor credit apply for a business loan?
Technically yes. Your company will likely get one or more loan options with all the business loans explained here. Some loans do not require credit scores, like MCAs. So you might want to start from there.
How fast is the approval of business loans?
It will depend on the type of loan and the lender. Online lenders like New York Tribeca Group can approve loan applications in a matter of hours. You must ensure you qualify for the loan and have the required documents ready before applying. In some cases, some loans might take days to approve, like traditional loans.
What if I default on the loan?
Lenders will assume ownership of the collateral involved in the loan in case you default. However, there are instances when there’s no asset provided as collateral. If this happens, the lender can rely on the borrower’s personal guarantee. They can own any personal and business assets of the borrower declared on the agreement and sell them.
How much can I borrow from a business loan?
Your credit score, age of your business, and financial history are some factors affecting the amount of money you can borrow. Every lender implements criteria on the amount they can approve to borrowers. These factors will prove that you can repay the loan. As you already know, lenders will not approve a loan amount that you cannot pay on time.
How straightforward is applying for loans online?
The business loans explained above involve different application processes. One of which is an online application. Most online lenders guarantee that borrowers can apply and get approved within hours. They basically ask you to fill out a form and upload the documents needed. All you need to do is wait for someone to contact you for further discussions.
Are there penalties for early repayments?
Some accept repayments. Other lenders advise their borrowers to remain on the repayment plan to avoid additional charges. In some cases, despite making early repayments, borrowers still need to pay the interest and other fees for the entire loan term.
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