Types of Small Business Loans
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Running a business is no small feat, and considering the economy's current situation, it is natural to feel overwhelmed about keeping your business up and running. There are many reasons why your business might need money, and fortunately, there are small business loans.
However, one loan cannot fit every business type, and this is why you have several options to choose from. Before you get financing for the business, you need to choose the right type of loan that fits your needs. This guide explains the different types of loans available to you.
In this article
What is a small business loan?
A small business loan is a financial product designed to provide capital to small businesses that need funding for various purposes. It is a form of debt financing obtained from a financial institution, such as a bank or credit union, or alternative lenders like online lenders or government-backed loan programs.
Small business loans typically have specific terms and conditions, including interest rates, repayment schedules, and collateral requirements. The loan amount can vary based on the needs of the business, ranging from a few thousand dollars to several million. Small business owners often seek loans to fund various business activities, such as starting a new venture, expanding operations, purchasing inventory or equipment, hiring employees, or managing cash flow. Loans can also be used for refinancing existing debt or addressing temporary financial challenges.
Exploring different loan options, comparing interest rates and fees, and understanding the terms and conditions can help make an informed decision.
Fast and flexible financing for your business
Running a business takes everything you have. Getting fast and easy funding doesn't have to.
- Apply Online In Minutes
- Decision as fast as 24 hours
- Receive between $25k-$6m
What are the types of small business loans available?
Several types of small business loans are available to cater to different needs and circumstances. Here are some common types of small business loans:
Term loans
These loans provide a lump sum upfront, which is repaid over a specific term with regular fixed or variable payments. Term loans are commonly used for business expansion, purchasing equipment or inventory, or funding long-term investments.
Lines of credit
A business line of credit allows you to access funds up to a predetermined limit. You can withdraw and repay funds like a credit card as needed. Lines of credit are useful for managing cash flow fluctuations, covering short-term expenses, or seizing immediate opportunities.
SBA loans
The U.S. Small Business Administration (SBA) offers loan programs that the government partially guarantees. SBA loans typically have longer repayment terms, lower interest rates, and more flexible eligibility requirements than traditional loans. The 7(a) Loan Program is the most popular SBA loan program.
Equipment financing
This type of loan is specifically designed to help businesses purchase or lease equipment. The equipment being financed typically serves as collateral for the loan, making it easier to qualify for financing.
Invoice financing
Also known as accounts receivable financing or invoice factoring, this option allows businesses to borrow money against their outstanding invoices. The lender advances a percentage of the invoice amount and collects payment directly from the customers. It can be helpful for businesses that have outstanding invoices but need immediate cash flow.
Microloans
Microloans are small-sized loans, typically ranging from a few thousand dollars to around $50,000. These loans are offered by nonprofit organizations, community development financial institutions (CDFIs), or some government agencies. Microloans are often used by startups or small businesses that may not qualify for larger loans.
Business credit cards
Business credit cards provide a revolving line of credit that can be used for various business expenses. They offer convenience and flexibility; some cards come with rewards or cashback programs. It's important to manage credit card usage responsibly and pay off balances in a timely manner to avoid high interest charges.
These are just a few examples of the types of small business loans available. Each loan type has its advantages, eligibility requirements, and terms, so it's essential to research and compare options to find the most suitable financing solution for your business.
Fast and flexible financing for your business
Running a business takes everything you have. Getting fast and easy funding doesn't have to.
- Apply Online In Minutes
- Decision as fast as 24 hours
- Receive between $25k-$6m
How much does a small business loan cost?
The cost of a small business loan can vary based on several factors, including the type of loan, the lender, the loan amount, the repayment term, the borrower's creditworthiness, and the prevailing market conditions. Here are some common costs associated with small business loans:
Interest rate
The interest rate is the primary cost of borrowing and is typically expressed as an annual percentage rate (APR). The interest rate can be fixed or variable. Fixed interest rates remain the same throughout the loan term, while variable interest rates can fluctuate based on market conditions. Generally, borrowers with stronger credit profiles and financial stability are more likely to secure loans with lower interest rates.
Fees
Lenders may charge various fees associated with the loan. Common fees include origination fees (charged for processing and underwriting the loan), application fees, closing costs, and prepayment penalties (charged for repaying the loan early). It's essential to carefully review the loan's fee structure and factor in these costs when calculating the total loan expense.
Collateral
Some small business loans require collateral or personal guarantees, especially for higher-risk loans. If collateral is required, the borrower may need to pay costs associated with appraisals, insurance, or other related expenses.
APR vs. factor rate
For certain types of loans, such as merchant cash advances or invoice financing, the cost of the loan may be expressed as a factor rate instead of an interest rate. A factor rate is a decimal figure multiplied by the loan amount to determine the total repayment amount. For example, a factor rate of 1.2 means the borrower will repay 1.2 times the loan amount.
It's important for business owners to carefully consider the total cost of the loan before accepting the terms. Comparing offers from multiple lenders, reviewing the terms and conditions, and calculating the total repayment amount can help assess affordability and determine the most cost-effective loan option.
It's worth noting that some government-backed loan programs, like those offered by the SBA, may have lower interest rates and fees than traditional loans, making them more cost-effective for eligible borrowers.
When should you apply for a small business loan?
Small business loans are suitable for a variety of business owners and situations. Here are some situations in which applying for a small business loan might be beneficial:
- Startups. Entrepreneurs launching a new business often require initial funding to cover startup costs, such as acquiring equipment, securing a location, hiring employees, and marketing. A small business loan can provide the necessary capital to get the business off of the ground.
- Business expansion. Established businesses looking to expand their operations, open new locations, diversify their product or service offerings, or enter new markets may need additional capital. A small business loan can fund these growth initiatives and provide the necessary resources for expansion.
- Equipment or inventory purchases. Businesses that require specialized equipment, machinery, or inventory to operate or increase production capacity can use small business loans to finance these purchases. This is common in industries such as manufacturing, construction, and retail.
- Cash flow management. Seasonal businesses or those experiencing temporary cash flow gaps may benefit from a small business loan to manage day-to-day expenses, pay employees, and bridge the gap between receivables and payables.
- Business improvements. Suppose a business needs to make renovations or improvements to its physical space, such as remodeling, upgrading technology systems, or enhancing infrastructure. In that case, a small business loan can provide the necessary funds.
- Business opportunities. Sometimes, a business may come across a time-sensitive opportunity that requires immediate capital. This could include purchasing discounted inventory, securing a large contract, or participating in a trade show or industry event. A small business loan can help seize these opportunities.
- Refinancing debt. Business owners who want to consolidate high-interest debt or refinance existing loans with more favorable terms can use a small business loan to improve their financial situation and potentially reduce monthly payments.
It's important for business owners to evaluate their specific needs, financial situation, and ability to repay the loan before applying for a small business loan. Additionally, understanding the potential impact of debt on the business's cash flow and profitability is crucial to make an informed decision.
Fast and flexible financing for your business
Running a business takes everything you have. Getting fast and easy funding doesn't have to.
- Apply Online In Minutes
- Decision as fast as 24 hours
- Receive between $25k-$6m
When shouldn't you apply for a small business loan?
While small business loans can be beneficial in many cases, there are certain situations where applying for a small business loan may not be the best course of action. Here are some scenarios where businesses may want to reconsider applying for a small business loan:
- Inability to repay. If a business is already struggling financially and does not have a reliable and sustainable source of income to meet its existing financial obligations, taking on additional debt through a small business loan may worsen the financial situation. It's important to carefully assess the ability to repay the loan and avoid overburdening the business with excessive debt.
- Unproven business concept. If the business is still in the early stages and has not yet proven its concept or achieved a stable revenue stream, lenders may view it as a higher risk. In such cases, securing a small business loan might be challenging, and alternative funding options or focusing on business development might be more appropriate.
- Lack of collateral or creditworthiness. Some small business loans require collateral as security, such as property, equipment, or inventory. If the business does not have sufficient collateral to offer, or if the owner's personal or business credit history is poor, obtaining a traditional small business loan from a bank may be difficult. Exploring alternative lenders or improving creditworthiness could be more suitable in such circumstances.
- Short-term financing needs. If the funding requirement is for short-term or temporary purposes, such as covering a small cash flow gap or funding a one-time project, seeking a small business loan with long-term repayment obligations may not be the most efficient solution. Exploring options like business credit cards, lines of credit, or invoice financing could be more appropriate.
- Insufficient return on investment. Before applying for a small business loan, it's important to evaluate the potential return on investment (ROI) of the intended use of funds. If the projected ROI is not substantial or the business does not have a clear plan to generate enough revenue to cover the loan costs and generate profits, it may be wise to reconsider the loan application.
Pros and cons
Pros
- Access to Capital. Small business loans provide access to much-needed capital that can be used for various business purposes, such as expanding operations, purchasing inventory or equipment, hiring employees, or investing in marketing.
- Business Growth. With additional funding, businesses can seize growth opportunities, increase their market presence, and expand their operations, which can lead to higher profits and long-term sustainability.
- Building Credit. Successfully repaying a small business loan can help establish and improve the credit history of the business. This can be beneficial for future financing needs, as a strong credit profile makes it easier to qualify for larger loans or obtain more favorable terms.
- Control and Ownership. Unlike seeking funding from investors who may demand ownership or control in the business, a small business loan allows the business owner to maintain full control and ownership.
- Tax Deductibility. In many cases, the interest paid on a small business loan is tax-deductible, which can help reduce the overall tax burden of the business.
Cons
- Debt and Interest Payments. Taking on debt means having regular loan repayments, including interest charges. This reduces the available cash flow and can impact profitability, especially during periods of low revenue or economic downturns.
- Qualification Requirements. Qualifying for a small business loan can be challenging, especially for startups or businesses with less established credit histories. Lenders often require collateral, strong personal and business credit scores, and a demonstrated ability to repay the loan.
- Fees and Interest Rates. Small business loans may come with fees, such as origination fees or prepayment penalties. Additionally, interest rates can vary depending on factors like creditworthiness and the type of loan, and higher interest rates can increase the overall cost of borrowing.
- Personal Liability. In some cases, small business loans may require a personal guarantee, making the business owner personally liable for repaying the debt. This means personal assets could be at risk if the business fails to meet the loan obligations.
- Impact on Cash Flow. Loan repayments, especially with fixed monthly payments, can impact the business's cash flow and limit its ability to handle unexpected expenses or invest in other areas of the business.
The bottom line
The best small business loan option depends on how you intend to use the funds for your business. Before you look at short-term funding, consider SBA loans and term loans. And if you already have a business account with a bank, consider applying for a loan at the same bank to enjoy special offers on rates. No matter the purpose of borrowing, adjust your budget so that you can repay on time and borrow only what you require, even if you qualify for a larger amount.
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