Types of Business Loans & How to Decide
Deciding which type of business loan can be troublesome for some business owners, given how many different types of business loans are out there. It is important to select a business loan that will do your business the most good, helping it to grow and prosper while leveraging debt to do so.
Keep reading to learn more about the different types of business loans and how to decide which loan is best for you.
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Business Term Loans
Business term loans are loans that are for a specific amount of money, paid back over a set period of time, with a rate repayment schedule.
These are the best business loans to apply for if you want to expand your business, purchase real estate, purchase another business, renovate your business, or even hire more staff.
Here are some things to know about business term loans:
- Renewed annually for a fee. Usually have to be paid in full to qualify for renewal.
- Lowest interest rates. They are seen as the least risky.
- Better rates with a better business credit score. You are more likely to get a bank to finance you and give better terms if you have an excellent business credit rating.
- Loans range from $5,000 up to $2,000,000.
- Fixed payments. Business term loans offer flat rates and fees, so you always know the cost of the loan.
- Fixed terms. Business term loans are usually set for 1-5 years.
How to Decide If a Business Term Loan Is Right for Your Business
You may want to get a business term loan if you plan on expanding your business, doing some renovations, or hiring more staff. This type of loan is important for growing your business.
Things to consider:
- Determine which direction to grow your business. Which direction do you want to grow your business? Do you want to leverage employees? Do you want to improve your business image? These can be accomplished with a business term loan.
- Incorporate a business term loan into your business plan. How long do you need the loan? Are you able to afford the loan payments? Will the loan get you where you want to be in your business? Does it meet your financial goals?
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Small Business Line of Credit
A business line of credit is less like a traditional term loan and functions more like a business credit card in the sense that it is a revolving line of credit used for short-term financing purposes.
Small business lines of credit are useful because they can help take care of daily expenses such as purchasing supplies, paying payroll, paying net-30 vendors, and other regular business expenses.
Revolving lines of credit make it easier for businesses to free up cash flow and weather slow economic times.
Here are some things to know about small business lines of credit:
- Helps build business credit. These loans are great for helping small businesses build and improve their business credit scores and business credit profiles.
- Lower interest rates than a business credit card. Though they function much the same way, the interest rates on a small business line of credit are typically much lower than a secured or even unsecured business credit card.
- Use the money for anything. These types of loans are used for a variety of purposes, with few limitations.
- Borrow only what you need. Because these are revolving lines of credit, you have access to the money, but if you don’t need it, you don’t have to borrow it.
- Use for short-term financing needs. These loans are short-term loans with monthly payments based on what you can afford to pay beyond the minimum payment. The interest is still higher than a business term loan, so it is best to pay them down as much as possible each month to avoid paying exorbitant interest on the loan.
How to Decide If a Small Business Line of Credit Is Right for Your Business
You may want to get a small business line of credit if you don’t have a lot of guaranteed revenue coming in each month. This type of loan is important for helping you maintain cash on hand to pay bills and other necessary short-term expenditures.
Things to consider:
- Look for the best rates. Interest with these working capital loans begins immediately once you draw on the funds. Make sure you only draw on them when you need them to avoid paying more in interest.
- Renew annually. A small business line of credit must be renewed every year, and that decision is primarily based on your business credit score. Make sure you’re pulling your credit reports regularly to ensure you continue to qualify for these loans.
- Watch out for blanket liens. If you borrow over $100,000 with these working capital loans, you may be required to secure the loan with a blanket lien, which means your lender can come after both business and personal assets if you can’t or don’t pay the loan.
- Monitor your spending. Just like with business credit cards and other revolving credit lines for businesses, you must monitor spending with a business line of credit as spending can get out of control if you’re not careful. Don’t overextend your business credit, or you could end up having cash flow problems later on.
SBA 7(a) Loans
The most common business loan is the Small Business Administration (SBA) 7(a) loan. These loans are guaranteed by the SBA.
These loans are great because they are intentionally designed to help small businesses succeed.=
Here are some things to know about SBA 7(a) Loans:
- Maximum loan amount of $5,000,000. These loans are great for helping small businesses build and improve their business credit scores and overall operations.
- Most affordable loan. SBA 7(a) loans tend to offer the best interest rates and loan terms for small businesses.
- Approval process takes time. SBA 7(a) loans take time to get approved. Once approved, it will still take a month or longer before funds are made available to your small business.
- Solution for small businesses that can’t qualify for traditional loans. Because these loans are backed by the government and designed to assist small businesses and business startups, they are a great solution for businesses that cannot get traditional financing.
Recommended: Learn How to get a SBA 7(a) Small Business Loan.
How to Decide If an SBA 7(a) Loan Is Right for Your Business
You may want to get an SBA 7(a) loan if you are starting a new business. This type of loan is the most popular loan for startup businesses and small businesses in general.
Things to consider:
- Know the eligibility requirements. SBA 7(a) loans have some eligibility requirements that must be met before an SBA loan will be approved.
- Plan to borrow the money later out into the future. Because approval can be a lengthy process and because you’ll need some established business credit, it’s important to plan a year or two out in advance when considering this loan.
- Make sure you have your loan documents ready. There are many business documents you’ll be required to produce. It is a good idea to have these documents in a separate folder with your business plan.
Factoring Loans
Factoring loans are accounts receivable loans that are secured by your outstanding accounts.
They are a nice choice if you need money quickly and are having problems collecting on accounts receivables.
Here’s how factoring loans work:
- Contact a factoring company. There are many factoring loan companies that will buy your accounts receivables and purchase orders. Choose a company that has a proven track record, and one that fits your company’s needs.
- Fill out an online application. The application usually requires submitting some basic business details and contact information.
- Wait for a call. Once you’ve filled out the application, a loan agent will contact you and explain the terms, rates, etc. and collect more information from you.
- Get approved. Once you’ve provided the necessary information, and it’s determined that your business is a low-risk proposition based on the business credit of your accounts receivables, you’re likely to be approved.
- Get funds. Funds usually arrive in one to five days for most factoring loans.
How to Decide If a Factoring Loan Is Right for Your Business
You may want to get a loan if you are cash strapped because of lots of account receivables pending. This type of loan is important because it can free up cash flow to run your business.
Things to consider:
- Factoring loans charge fees and take a percentage of your unpaid pending accounts receivables. Usually, this fee is anywhere from 1%-2.5%.
- Your clients pay the factoring loan directly. The factoring company is paid by your customers. This means you must give up some control over your business.
- Instant working capital. You can continue using the factoring loan approach to free up working capital consistently.
- Factoring company does the collecting for you. No longer are you required to beg and plead with customers to pay you. The factoring company handles this.
Microloans
Microloans are small loans that typically do not exceed $100,000. These loans are a good choice for business startups or small businesses needing some extra capital to expand, free up cash flow, or make an investment.
Here’s how microloans work:
- Contact a microlending company. Many microlending finance companies will set your business up with a microloan.
- Fill out an online application. The application usually requires submitting some basic business details and contact information to the microloan company.
- Wait for approval. The time it takes to get approved for a microloan can vary based on the individual microlending agency.
- Get funds. Funds usually arrive in about 10 days once your business has been approved for the microloan.
How to Decide If a Microloan Is Right for Your Business
You may want to get a microloan if you desire to expand your business and have low cash reserves. This type of loan has helped countless poor people start businesses around the world, empowering entrepreneurship around the world.
Things to consider:
- Higher interest rates. Most microloans charge 7.5%-13% interest.
- Be of good character. Often a requirement for getting a microloan is good character, meaning you have no criminal background, etc.
- Less money. If you only need a low amount of money, then a microloan may be a good choice. In 2017 the average microloan amount was approximately $13,000.
- Longer repayment terms. Though the loan amount is less, the time to pay the loan off is generally more favorable than a traditional bank loan. In most cases, you can take five to ten years to pay off the loan.
- Limited credit is okay. You can often still get approved for a microloan with a limited credit history. Regardless of your past credit history or lack of credit, you may well get approved for the loan.
- Good option for sole proprietorships. If you are a solo business owner, a good loan option may be a microloan. Where a traditional bank is unlikely to approve you for a loan, a microlending institution may qualify you.