Small Business Loans: What You Need to Know Before Applying
Entrepreneurs often need to take out loans to start or grow their businesses. Before applying for a loan, they must prepare for the process and understand what it entails. Eligibility requirements must be thoroughly researched, and the borrower must be aware of the repayment terms, among other key details. With this information, they increase the odds of being approved for the funding they need.
Business Loan Options
Business owners often request a term loan so they know the payments they will make over a predetermined period. These loans function much as mortgages and auto loans do. Lines of credit provide them with flexible access to funds. They can draw money from their lines of credit as needed. Interest is only charged on the amount they use.
Small Business Administration loans are another option entrepreneurs should consider. They come with low interest rates and longer repayment terms. Extensive documentation is required with this type of loan. Equipment financing is a secured loan, and the equipment serves as collateral. Individuals with past credit issues may need to consider Unsecured Finance options, but they typically pay a higher interest rate because the lender assumes more risk.
Eligibility
Each lender determines the eligibility requirements for its products. Most lenders require borrowers to have a strong credit score, typically 680 or higher, for favorable terms. The business must have consistent revenue dating back at least one or two years, and it must provide a detailed business plan. Some lenders work with startups, but not all do. When evaluating a borrower, the lender examines their debt-to-income ratio to ensure that the payments can be made as agreed. The business owner may be required to provide collateral for the loan, particularly if it is a new business or they have a low credit score.
Interest Rates
Interest rates vary by lender, loan type, and the borrower’s credit score. An SBA loan may have a four percent interest rate, while alternative lenders offering unsecured loans might charge as much as 30 percent. The interest rate on a variable-rate loan may fluctuate based on current market conditions, so borrowers need to determine whether they can handle these fluctuations in the future.
Fees
Borrowers must also learn about the fees that will be assessed when they secure a loan. Origination fees can be as high as six percent of the loan amount. Prepayment penalties can be costly if the borrower repays the loan early, and late payment fees can quickly accumulate. Borrowers must consider the annual percentage rate to determine the loan’s total cost, including the interest and fees.
Loan Risks
Entrepreneurs must carefully consider whether taking out a loan is the right move for the business. What happens if the owner is unable to pay the loan as agreed? Taking on excessive debt can lead to cash flow problems. Seasonal businesses and those with inconsistent revenue often struggle to repay the funds. While unsecured loans have no collateral requirements, the interest rate is usually significantly higher, so the borrower pays more over the life of the loan.
Every person should consider alternatives to a loan. Crowdfunding, bootstrapping, and angel investors are three options to research, as the business won’t take on debt. Another option to consider is applying for grants. Although the application process is competitive, a company may still be eligible to receive these funds.
Every business owner should carefully review their finances before taking out a loan. The more information they have, the easier it is to make an informed decision that will ultimately benefit the business. The right loan will allow the entrepreneur to achieve their goals without sacrificing financial stability.
