A business loan is a loan specifically intended for business purposes. As with all loans, it involves the creation of a debt, which will be repaid with added interest.
A business loan is any kind of loan offered to a commercial entity, rather than an individual person. Typically, a business loan can range from as little as $1,000 up to several million. Repayment terms can vary from one month to 15 years, depending on the type of loan and the lender.
Business loans are lending agreements made between business owners and banks or private lenders. Businesses need capital, either to fund operations or simply to start themselves up and begin turning a profit. Banks and lenders are willing to give them the money in advance, so long as they pay it back on an agreed-upon schedule, with interest.
Characteristics of Business Loan
- Time to maturity
- Time to maturity describes the length of the loan contract. Loans are classified according to their maturity into short-term debt, intermediate-term debt, and long-term debt. Revolving credit and perpetual debt have no fixed date for retirement. Banks provide revolving credit through the extension of a line of credit. Brokerage firms supply margin credit for qualified customers on certain securities. In these cases, the borrower constantly turns over the line of credit by paying it down and reborrowing the funds when needed. A perpetual loan requires only regular interest payments. The borrower, who usually issued such debt through a registered offering, determines the timing of the debt retirement.
- Repayment Schedule.
- Payments may be required at the end of the contract or at set intervals, usually on a monthly or semi-annual basis. The payment is generally comprised of two parts: a portion of the outstanding principal and the interest costs. With the passage of time, the principal amount of the loan is amortized or repaid little by little until it is completely retired. As the principal balance diminishes, the interest on the remaining balance also declines. Interest-only loans do not pay down the principal. The borrower pays interest on the principal loan amount and is expected to retire the principal at the end of the contract through a balloon payment or through refinancing.
Interest is the cost of borrowing money. The interest rate charged by lending institutions must be sufficient to cover operating costs, administrative costs, and an acceptable rate of return. Interest rates may be fixed for the term of the loan, or adjusted to reflect changing market conditions. A credit contract may adjust rates daily, annually, or at intervals of 3, 5, and 10 years. Floating rates are tied to some market index and are adjusted regularly.
- Security. Assets pledged as security against loan loss is known as collateral. Credit backed by collateral is secured. In many cases, the asset purchased by the loan often serves as the only collateral. In other cases, the borrower puts other assets, including cash, aside as collateral. Real estate or land collateralize mortgages. Unsecured debt relies on the earning power of the borrower.
How do business loans work?
With a business loan you’re loaned a lump sum of money you then repay with interest in fixed monthly installments. A business loan can help you finance general business needs like inventory, equipment or vehicles.
What is a small business administration (SBA) loan?
A Small Business Administration (SBA) Express Loan is a long-term small business loan up to $250,000 that is partially guaranteed by the government. Unlike conventional term loans, an SBA Loan offers business owners the opportunity to take advantage of favorable terms as part of the SBA program, while removing some of the barriers to traditional financing options. And as a Preferred SBA Lender, our program offers a faster loan process with reduced paperwork for businesses that have been in operation for less than two years.
Different types of business loans
Depending on where the money comes from and the time in which it must be paid back, there are plenty of funding options for all kinds of great business ideas. Read on to learn about some of the most popular business loan options out there.
Term loans are the most common type of loan. They are what is typically thought of as a loan. The word “term” refers to the length of time between when the loan is issued and when it is paid off.
The term length can vary—some term loans can have term lengths anywhere from one to 25 years or more. The lender takes the status of the borrower’s business and credit quality when determining how long the term is. A new business with poor credit may only be able to secure a short-term loan with a high-interest rate, whereas a business that has been around for years and has good credit may be able to secure a long-term loan with a low-interest rate, or APR.
In a world of global corporations, small businesses have it rough. It can be hard to start a company from scratch, even if it’s a small one. The government’s way of solving this issue is to subsidize small businesses in the form of an SBA 504 Loan.
The SBA, or Small Business Administration, does not issue loans to small businesses, but through this type of loan, it guarantees to pay back a portion of a bank loan taken out by small business owners.
Some loans are secured, meaning the borrower has promised to put down an asset as collateral. Whether it’s stock, equipment, or other property, the asset acts as reassurance for the lender. The lender will get to claim the asset in the event that the borrower does not pay back the loan and interest.
Oftentimes lenders will even overlook poor company credit if there is a guarantee that an asset will be used to secure a loan. This practice is called asset-based financing.
Bank line of credit
While it is not a typical loan, a business line of credit is a similar form of debt financing. Rather than receiving a lump sum of money and paying it back in monthly installments, a bank line of credit operates more like a credit card for a business—just without the card. Money is used by the business as-needed, so there’s no risk of borrowing too much and not being able to pay the excess interest.
There are all sorts of loans out there for all sorts of businesses. Many lenders are able to offer lower rates to non-profits out of goodwill. Sometimes businesses choose equipment loans, or loans used to fund a specific piece of equipment. Small business and startup owners and advisors can use loan origination software to assist in finding loans that work for their needs.
What are the major factors that influence the availability of credit for small businesses?
This includes positive cash flow, bank history, payment history, and additional cash sources and reserves. The best way to show your credit capacity is with positive cash flow, a favorable bank rating, and positive payment history with other businesses.
Lenders have to believe that a business and its owners are reliable and can be depended on to repay on a loan, business line of credit, etc. The personal credit reports of an owner(s) and business credit reports of the company are the primary tools used to assess creditworthiness.
In addition, trade references will most likely be required on a business credit application as part of the credit decision making process. Typically, a credit application for a business will ask for three trade references.
Before applying for business credit, it’s important to evaluate both your personal and business credit files for accuracy. Be sure to clear up any issues or outdated information as soon as possible.
This is an evaluation of your company’s ability to repay on a loan or business line of credit. This includes positive cash flow, bank history, payment history, and additional cash sources and reserves. The best way to show your credit capacity is with positive cash flow, a favorable bank rating, and positive payment history with other businesses.
When it comes to payment history, banks, lenders, and suppliers want to know how long an account has been opened, the credit limit extended, and how many times the account has been paid late.
One of the factors bankers use during a business loan evaluation is the amount of funds the owner has invested in the business. Most likely there will be a more favorable consideration for a business loan if there is a “reasonable” amount invested in the business from the owner.
How much skin you have in the game is very important and can make the difference between an approval and denial. Banks examine the business’ debt-to-equity ratio to understand how much money you’re asking for compared to how much money you have already invested in your business. The smaller the ratio the better.
Commercial real estate, heavy machinery, business equipment, inventory, stocks and bonds, and other expensive business assets that can be sold if a business fails to repay the loan are considered collateral.
Once a bank accepts your collateral, it will determine the loan-to-value ratio of the collateral based upon the nature of the asset. Each lender considers the loan-to-value ratio differently, so you’ll need to ask your lender how they intend to set that value.
Most traditional banks require collateral with a business loan, but there are other lenders who do not require any collateral to approve a loan.