Small business loans can be very valuable to any small business that needs funding. While small business loans are similar to most loans, there are different types of loans, interest rates, and terms. It’s important to understand the difference between the loan types and repayment terms to find the best fit for your business. The editorial team, at MONEY.com, surveyed 42 loan providers to find the top 4 best small business lenders but also how all the different kind of loans work.
Here is an overview of their findings and the different types of loans offered.
What Is A Small Business Loan?
A small business loan is essentially a loan that is given to small businesses which is then required to be paid back with interest and some fees over a period of time. There are both long term and short terms loans which are the same as any other loan or line of credit. There are also government loans which are guaranteed by the Small Business Administration, which have better terms for the business, but stricter requirements to become approved.
What Should A Borrower Look for in A Small Business Loan?
Anyone who is looking for a small business loan needs to consider the reason for the loan, the dollar amount of the loan, the interest rate, costs, terms, prepayment penalties and other fees. Be wary of the loans that are very easy to qualify for as they will usually require higher APR (annual percentage rates) and extra fees.
There are many different small business loans that vary in their terms and duration of the loan:
1. Short-Term Loans
Short term loans are usually a loan with a one-year term but are sometimes required to be repaid within 3 to 4 months. In order to qualify for a short term loan, borrowers are usually required to show the past 3 to 5 year cash flow and income statements. Interest rates are typically higher for short term loans.
2. Long-Term Loans
Long term loans have a longer maturity and can be anywhere from 3 to 10 years and sometimes even longer. Long term loans amounts range from $25,000 to $200,000. To become approved for a long term loan, expect a more difficult application process. The interest rate on these loans vary but are usually based on the prime interest rate.
3. Line of Credit
A line of credit is essentially guaranteed cash that is available to you and can be used on any necessary purchases, repairs or whatever is necessary for your business. A line of credit can
help when a business is in need of cash before any revenue has been received. There is usually a cap on how much you can take out and you will be required to pay interest on the principal that is outstanding.
4. Invoice Financing
Just as the name suggests, invoice financing is a loan to pay back the outstanding invoices that a business might not be able to pay. The lender is giving you money that will be used against any income or accounts receivable generated.
5. Merchant Cash Advance
A merchant cash advance is an alternative for a business whose revenue is generated mostly from debit and credit card sales. The lender will give the business a cash advance and then require some of the revenue from future sales.
6. Equipment Loans
Equipment loans are used to buy equipment for your business. The equipment actually becomes the collateral for repayment. Therefore if there’s a default on the loan, the lender will repossess the equipment. Equipment loans are fairly easy to acquire.
Other than the above loans, the Small Business Administration will back low-interest rate loans to small business. While not lenders, the SBA will guarantee up to 85% of loans that are less than $15,000 and 75% of loans that are over $150,000.
Frequently Asked Questions
How does a company quality for a small business loan?
Every business loan is different but a guarantor is usually required if your credit history is poor, your business doesn’t have any earnings, a poor investment history or you have little cash flow. The guarantor is then responsible for repaying the loan if the business fails or is liquidated.
Do you need to have good credit to get a loan?
While it certainly helps, there are some lenders that are more lenient than others. For example, a lender might take into account the cash flow that will eventually be generated from the business and not worry about the credit history. For an SBA loan, good credit is a must.
What is the cost of a small business loan?
Business loans costs can vary for each borrower as the rates will be determined by the actual business. Keep in mind the costs of the loan, interest rate, APR and other costs that might apply. Make sure that you can repay the loan within their time frame and that the profits from your business will eventually exceed the loan amount.
What are the different loan term lengths?
Conventional bank loans are usually 3-10 years, while short term loans are between 3 months and 2 years. Long term loans are typically 1-5 years.
Is an Online Lender preferable to a bank?
Online lenders are a great alternative to a conventional loan when a business is a start-up or for borrowers with a weak credit history. The approval process is quicker and more lenient, but the repayment terms tend to be within a shorter time frame than other lenders.
Now that you know a little more about how small business loans work, you can decide which loan and lender is the best fit for you. Have a list of questions ready and make sure to get quotes from at least 2 to 3 lenders to see which company gives you the best deal.