Small Business Loan Basics
A business loan is a type of loan which is issued by a financial institution to help finance the start-up or expansion of a new business. Business loans are commonly issued by banks, but may also be obtained from other lenders.
Because they are often unsecured, business loans typically have lower interest rates than other types of loans and their repayment terms can be extended as needed. Borrowers pay back the principal amount plus any accrued interest. Business owners sometimes use loans to purchase equipment or hire employees, or both in some cases.
Business loans come with many advantages for borrowers because the borrowing process itself often takes less time and paperwork than obtaining credit from one's own bank account without having to first prove your creditworthiness.
Business loan applications can be processed quickly, and usually do not require a credit check. Business loans are almost always available with variable interest rates, which makes it easier to plan for your business budget. Since most business loans are unsecured, the approval process is more straightforward and less time consuming than for most other types of loan applications.
Business loans are based on the financial history of the business, not on that of its owner(s) or its owners' credit scores. In contrast, many other types of loans require one or more personal guarantees from co-borrowers or the borrower's spouse in addition to being based on their creditworthiness.
Because business loans are unsecured, they can be applied for by anyone who can demonstrate a legitimate business need. This usually means forms that require less information than would a personal loan application because the company is already in existence.
Loan terms may vary – depending on the financing source – but typically range from 2 years to 10 years before a loan becomes due and must be repaid in full. Capital One offers a 6-month term loan with an interest rate of 10% with payment dates starting at the end of your first monthly statement period following approval for this type of financing.
As with any loan, there are disadvantages to business loans. The biggest disadvantage is the level of risk involved —unsecured loans carry greater risk for the lender than secured loans do. For example, a bank that lends money using collateral as security (like a mortgage) is much less likely to lose its investment than a bank that issues an unsecured business loan because the borrower could default on the payment and leave nothing for reimbursement in case of default.
Because of their higher level of risk, lenders charge higher interest rates on unsecured loans than they do on secured loans. This makes small business loans more expensive than other types of financing and more difficult for many borrowers to obtain.
The disadvantage of business loans is that there are not many sources for them. Applying for a business loan requires filling out lengthy application forms that may require submitting personal information and documentation. For this reason, many small businesses do not consider these types of loans until they are ready to start or plan to expand their operations.
As with other types of loans, the financing process can be tedious and time-consuming. Lenders usually expect borrowers to provide extensive documentation relevant to their case — a significant amount of time and money may be needed to get a loan approved in good standing. Borrowers must obtain references and provide their own documentation to prove their ability to repay the loan.
Lenders review all business loan applications and are inclined to believe that borrowers are legitimate and can repay the loan in full. This is why many small businesses consider applying for a business loan only after they have already received a large amount of other lending from banks or other financial institutions.
Once a borrower has proven his/her ability to make payments, lenders are willing to work with borrowers who may face unforeseen circumstances beyond their control. For example, some businesses may be sold before they are able to pay off their loans. In this case, the new owners must either make arrangements for servicing the loan or purchase it onto their balance sheets.
The disadvantages of business loans are often outweighed by the advantages of having startup capital, lower interest rates and flexible payment terms. Relying on other types of loans for startup capital can be risky because the amount borrowed is usually large compared to the borrower's income. Additionally, if a borrower falls behind in payments and cannot make them, the lender will seize a portion of what remains owed on the loan and sell it to recover its losses or to liquidate it entirely.
Lenders may still be willing to work with a borrower whose business is experiencing financial setbacks and may accept the fact that he or she will take more time to repay the loan. Borrowers who know that they will need more time to repay their loan in full may be willing to take a more flexible repayment schedule, especially if the lender can help them substantially reduce interest costs and cut down on other business expenses.
Business loans can assist borrowers in hiring and expanding their workforce, purchasing new office equipment and other capital assets, meeting payroll and payroll taxes requirements, or installing new software. The list of things that a business can buy using a business loan is nearly endless.
Although business loans are often a good option for small businesses, they are not recommended to borrowers who already have significant personal financial debt or credit issues. These types of borrowers should also be careful about keeping their personal finances and credit in good shape because some lenders will deny business loan applications from these borrowers.
A business loan can best be described as a short-term, interest-bearing loan that is not likely to be used to cover the borrower's daily expenses (with the exception of operating costs). A business loan is not designed to help a borrower with day-to-day operations or use it to pay down any existing outstanding debts.
One of the advantages of business loans is that they can be used to help finance purchases that are not usually allowed by credit cards, personal loans or lines of credit. Business loan amounts can be large and the terms extended for many years, making this type of financing very attractive to some borrowers. Many types of business loans are also available with flexible payment terms — helping borrowers meet their current financial obligations while still meeting the requirements listed in their loan agreement.
This type of financing is usually arranged through a financial institution like a bank or another lender who specializes in providing business financing to small businesses.
Conclusion
There are many types of loans available to small businesses, each with their respective advantages and disadvantages. The best type of loan varies depending on the needs and financial standing of the borrower.
Business loans are one of the most common types of loans available to small businesses. Business loans are unsecured, which means they are not backed by any personal property or other assets — making them a very risky investment for banks or other lending institutions. As a result, lenders charge higher interest rates and fees for business loans than other types of financing such as bank overdrafts or credit cards.