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There are many reasons why your business might want to borrow money, and there are many financing options available to get the job done. While having a lot of loan options can be good, numerous financing choices also makes it essential to conduct research prior to applying.
Before you can get financing for your business, you need to choose the right type of business loan. Factors like your qualification requirements, loan purpose and desired loan terms can all influence the type of business loan that’s best for you.
SBA loans are business loans that are guaranteed by the U.S. Small Business Administration (SBA). Because the federal government guarantees to repay up to 85% of the loan amount if a borrower defaults, it reduces the level of risk involved for the lender.
Interest rates on SBA loans in 2021 can range from around 2.8% to 13%, though each SBA- approved lender determines the annual percentage rate (APR) it charges. Repayment terms may extend up to 25 years, depending on the specific loan program.
Three of the most popular SBA loans are:
Aside from traditional bank loans, SBA loans can be one of the most affordable ways for a business to secure financing. However, borrowing requirements can be extensive, and you typically need a personal credit score of 680 to qualify. The loan process can also take several weeks or even months to complete.
Term loans are what many people think of when they search for small business loan options. With a term loan, your business borrows money from a traditional bank, credit union or online lender. Then, you repay the funds over a fixed period of time (and often at a fixed interest rate).
The terms and conditions of these loans vary, but a well-qualified business might be able to:
If you have good personal and business credit scores, you may be able to get a competitive interest rate on a term loan—especially from a traditional lender. And with online lenders, term loans often feature faster application and funding processes. On the negative side, you may need to supply a personal guarantee—which is a legal agreement you make to repay the loan with your personal funds if the business fails to do so—and/or collateral for this type of funding.
If your business needs cash in a hurry and values repayment terms under three years, a short-term business loan might be worth considering. With some online lenders, qualifying businesses might be able to access funding in as little as one day.
Numerous factors can influence the details of your short-term loan. But a well-qualified business might be able to find loan offers to:
Fast funding speed and easier qualification terms are the key benefits of short-term loans. Yet these loans feature some disadvantages too. First, APRs can be high for some borrowers, and you might face expensive fees like origination, prepayment penalties, etc. You might also have to agree to daily or weekly payment drafts with some lenders.
Your company may need to be established for at least one year before it can qualify for particular business funding options. For new businesses that need to borrow money sooner, a startup business loan might be a good fit.
Startup business financing comes in a variety of options—from SBA microloans to online loans to business credit cards. Because there’s a lot of variety here, interest rates, fees, loan amounts and repayment terms can vary. It’s important to compare multiple loan options whenever you’re seeking business financing for startups.
Startup loans are often available to businesses with little-to-no established credit or time in business. Yet they can sometimes be an expensive way to borrow money. On a positive note, startup loans tend to be easier to qualify for, even as a new business. And a well-managed startup loan may help you build better business credit for the future.
A business line of credit is a type of financing that lets you borrow money on an as-needed basis and pay interest on only what you borrow. In some ways, it works like a credit card. The issuing bank approves you for a credit limit and as you use and repay the money you owe, you can access that same credit line again throughout the draw period.
However, eventually, the draw period may expire (often after 12-24 months), and you’ll no longer be able to access the credit line when that happens. At that point, the repayment period begins, which can last up to five years.
Business lines of credit can be a flexible way to borrow money if you need an open source of funding. They can also work well for projects with undetermined costs.
However, getting a business line of credit with the best borrowing terms usually requires good credit and sometimes collateral. You might also have to sign a personal guarantee, typically with unsecured credit lines. Additionally, interest fees typically kick in right away when you withdraw funds with no grace period like credit cards offer.
Microloans are a financing option that features small loan amounts and short repayment terms. Interest rates tend to be low (or nonexistent in some cases), and the qualification criteria are often less stringent compared with other business loans.
Eligible businesses may be able to borrow up to $50,000, typically from nonprofit organizations. Most microlenders focus on underserved small business owners, such as women and minorities.
Microloans can provide underserved small business owners with an infusion of cash to get a startup off the ground or to help an existing business grow. However, microlenders may ask for a personal guarantee and collateral in order to secure funding.
If your business provides a product or service to other businesses and uses invoices to collect payments, it might be eligible for invoice factoring. With this type of financing your business sells its outstanding B2B invoices to a third party.
The factoring company buying your invoices might advance 70% to 95% of their total value upfront. From there, the company collects the outstanding payments from your customers, deducts a factor fee (typically 0.5% to 5% per month, per outstanding invoice), and returns the difference to you.
There are two types of invoice factoring—recourse and non-recourse.
Invoice factoring can help your business access cash on outstanding invoices before they are due. Qualifying for this type of financing is often easier than qualifying for other types of business loans. However, the factoring company may review the credit of your customers during the application process to make sure those businesses are likely to pay as agreed. This fast cash flow solution can also be expensive, especially if your customers pay late often.
Invoice financing works a lot like invoice factoring. Yet with this business funding option, you don’t sell outstanding invoices to a third party. Instead, your invoices serve as collateral to help you secure a cash advance, often up to at least 80% of the value of your outstanding invoices.
With invoice financing, you stay in charge of collecting from your customers. When your customers pay you, you repay the lender that issued you the cash advance.
When you back a loan using your invoices as collateral, your customers aren’t aware. This may be preferable to working with a factoring company that will call your customers to collect, alerting them to the fact that your business is leveraging its accounts receivable for funding. Invoice financing can still cost a lot of money though, with lenders often charging 0.5% to 5% per week until you collect your invoices and repay the loan.
Businesses that need help covering the costs of day-to-day operations might need a working capital loan. These short-term business loans can work for seasonal businesses and others that need access to capital until revenue picks back up in the future.
You can get a working capital loan from some online lenders and traditional financial institutions. These financing options may be available as SBA loans, term loans, lines of credit or invoice factoring. Due to the variety of options, your loan terms can vary widely too. For example, APRs may range anywhere from 3% to 99% with this type of financing.
Some working capital loans feature qualification requirements that are easier to satisfy. (Though that’s not generally the case with SBA loans.) But your creditworthiness, loan type and other factors will influence the cost of the loan. If you have a FICO score of less than 600, you might still qualify for funding. But lenders may offer you less attractive borrowing terms.
A merchant cash advance (MCA) is another way to access financing based on the promise of future revenue. When you apply for this funding option, a merchant services company may examine your daily credit card sales and the amount you wish to borrow. From there, the company can determine how much money it’s comfortable advancing your business.
If you qualify for this type of financing, the merchant services company may require you to make payments each day, often via automatic bank draft. The amount you repay is typically a percentage of your daily credit card sales. Fees can vary. But factor rates commonly range from 1.2 to 1.5.
Merchant cash advances can help businesses with high credit card volume access cash fast. This type of financing can be easy to qualify for compared with alternative funding options. You might even qualify with bad credit.
Yet this convenience comes at a cost. Factor rates tend to be higher than the interest rates you’d pay on a business term loan and other types of financing. And letting a merchant services company take cash out of your account each day could create future cash flow problems.
If your business needs money to purchase equipment or machinery, equipment financing could be a good solution. The equipment you purchase serves as collateral for the loan. If you default, the lender can repossess and resell the equipment to recuperate some of its losses.
Because the presence of collateral lowers the lender’s investment risk, you may be able to lock in competitive interest rates. APRs often range from 8% to 30%, and the loan amount varies depending on the cost of the equipment your business needs and other factors. Lenders may offer repayment terms of up to 25 years on this type of loan.
Your credit can play a meaningful role in your business’ ability to secure equipment financing. With good credit, you have better approval odds and may be able to get better interest rates. Bad credit, meanwhile, is an obstacle that could make it difficult to find a competitive equipment loan offer.
Businesses that need funding to buy commercial property might benefit from a commercial real estate loan. Like equipment loans, the asset you’re buying (the property) serves as collateral to secure the loan. In the event of a default, the lender can foreclose and sell the property to someone else, recovering at least some of its investment.
Your company’s ability to qualify, its APR and the amount it can borrow may depend on factors such as:
If you have good credit and you’re purchasing an asset with a favorable loan-to-value (LTV) ratio, you might be able to secure a low APR. Some lenders offer commercial real estate loans with interest rates as low as 3%.
However, if you have bad credit and opt to go through a hard money lender, the world of commercial real estate loans can be a lot different, and a lot more expensive. Not only may you face higher interest rates, but there could be prepayment penalties, balloon payments and more attached to your loan.
Some business owners use personal loans for business expenses; however, not all lenders allow it. Small business owners who are trying to get a new business up and running might consider this option since approval relies only on their personal credit and not a business credit score they probably haven’t established yet.
Loan amounts on personal loans are typically smaller than you might be able to secure with business financing options. And the maximum amount you can borrow may hinge on your personal debt-to-income (DTI) ratio. The average interest rate on a personal loan was around 9% in August of 2021, according to the Federal Reserve.
Using a personal loan to fund your business can sometimes be an easy financing solution for certain business owners. Yet when you put your personal credit on the line, the decision could come back to haunt you. If your business cannot keep up with the payments, you’ll be personally liable and your credit scores might drop. Furthermore, some lenders won’t allow you to use personal loan funds for business purposes.
Business Loans, Lines of Credit, Working Capital, Merchant Loans, Equipment Loans, SBA Loans, Loans
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