What is a business loan and why do you need it?
Starting or keeping up with a business can be overwhelming, but thankfully you have many options when it comes to funding your needs. Banks and credit unions have been the traditional way to get a business loan, but are no more the unique choice: online lenders have prospered, and made the process simpler and more accessible, especially if you have less than an optimal credit status and little business credentials to show. There are various types of business loans available, some of which are more suited to a specific purpose.
Typically, business loans are needed for:
- starting a business
- exploiting some opportunity of investment
- keeping up with recurrent expenses such as utility bills, rental costs, and paying employees’ wages
- financing equipment or inventory purchases
- filling the gaps of expected cash flow
- dealing with an emergency expense
- expanding the business.
Make sure that everything is clear to you if you decide to embark on such a loan, ahead of proceeding with it.
How does a business loan work?
Business loans allow you to borrow money to be used for the unique operations and goals of your business: as for any loan, you then have to repay that amount within the loan term, which is very variable, and during it, interest are also paid, along with fees. What varies, compared to a conventional simple loan, is that rates and limit amounts in proportion to the length of the loan are shaped on the utilization you are going to make of the borrowed money.
Repayment frequency is in most of the cases on a monthly basis, but for some lenders and depending on the loan type it can be weekly, or even daily, and interests will be applied accordingly to that schedule, so that you may have monthly, weekly or daily interest to pay. Interests and fees add up significantly to the cost of a loan, playing a major role in its affordability.
You can be financed both in the short and in the long term, which will affect how interest rates apply: you will usually have higher rate percentages on shorter loans, while with more years of financing you have to pay a greater interest amount, so it is up to you to choose which will be the best option. More often than not, financially hard times come, and consistent sums within little time can be needed: “short term loans” can last 3-18 months. In general, a business loan can have a length of up to 25 years.
Rates are determined by the single lender and according to your financial condition (credit score), revenue, time in business, and its industry, as well as based on type, term, and amount of the loan. They can be either fixed or variable: the latter is likely to be encountered, but you generally have the choice.
Traditional lenders, such as banks, have average annual percentage rates (APRs) going from 3% to 13%, considering all business sizes. If a small business is your case, you can be in the range of 3-6%, while through online lending companies rates are in the higher 8-12% as average. However, you will notice that their offers can go from going up to a whopping 100% (and beyond), but such high rates depend mainly on the amount of the loan and are aimed at the bigger businesses that can afford it.
When you see “APR” be mindful that it is not the same thing as the interest, but is generally comprised of interest plus the main fees, but every lender will consider it in a slightly different way, and you will have to read between the lines to understand if and which fees you must pay apart. Be sure you can afford and stay comfortable with those payments.
So, on top of interest, there are fees: lenders may apply all or some of them. They can be quite high, above all whereas you are offered with low rates, therefore must be accounted for in your budget. Among those, the most important is the “origination” fee, which serves to pay for the lender’s work of processing your application, which includes gathering information about you and coming up with the math. It can be a pre-set figure, or more commonly a percentage of what you borrow, in the range of 1-6%, to be paid upfront, otherwise included in the total cost of the loan (and subject to interest). There is usually also an “application” fee, which is for running the financial checks and for the time necessary to subscribe to the loan. A “late payment” fee is charged whenever a repayment is not done within the grace period; “prepayment/early payment penalty” is for borrowers who try to close the loan before the set term by making extra payments.
In most cases, you can borrow anywhere between $5,000 and $5 million, depending on the lender, your income and credit score, existing debts, and type of financing.
Business loans at a glance
| Interest rates | 3-100% |
| Amount limits | $5,000-$20,000,000 |
| Loan term | 3 months-25 years |
| Credit score | 500 as minimum |
| Required minimum revenue (yearly). | $50,000 |
Your credit score will greatly influence the rates you can access: the higher it is, the better, and eventually you should take time to improve it, for instance by paying off existing debts, or closing too many credit lines accounts. Most lenders will require to have a rating of 650 or above, but some others accept scores in the lower 600’s or even down to 500. Whereas it is allowed, a low score will come with high interest in proportion, but the rule is that lenders won’t qualify such a borrower, or deny the loan at all.
Business loans are in most cases secured, which means they will require a collateral asset on which to take possession in case of your inability to make the repayments, which could be a valuable item or equipment you own for business purposes. This is especially true for banks, while some alternative lenders can tolerate an unsecured loan, which means no collateral and no personal guarantee, by offering higher rates.
Instead of assessing the value of a specific asset, some lenders put a “blanket lien” on your business: this would mean foreclosing the whole of assets in the event you couldn’t repay the debt.
Business loans alternatives
A viable alternative to business loans are certainly the more traditional personal loans, which might come with more advantageous rates, and are useful for small business owners or fresh businesses who don’t have the need for big sums; while you avoid the high rates of a business loan, on the other hand, you can’t borrow so much, in fact, personal loans don’t exceed the limit amount of $100,000. They can be anyway a resort if you couldn’t qualify otherwise.
Grants for business financing are also available and should be sought before approaching a loan, in fact, they are free money, however, criteria of admissions are strict and only a few industries are considered. Besides, there will be usually a long waiting time until the funds can become available, and they are limited in amount, eventually turning out to be insufficient for a business owner. They can still be an important supplement to the other forms of financing if you are eligible for them: for example, the FedEx Grant can award small businesses up to $50,000.
Investor financing, also known as angel investors, involves people who are going to invest in your business, thus paying a certain amount upfront directly to you (that will be your fund), in exchange for an agreed percentage of your future revenue. This means you will repay them only if your earnings permit it. The degree of convenience depends on the numbers into play, and you will have to weigh your short vs long-term needs.
What is a SBA loan and should you get it?
A SBA (Small Business Administration) loan is a government-backed financial service that serves borrowers of varied conditions, funding different specific levels of a business, such as start-ups, growing capital, renovations, acquisitions, franchising, commercial real estate or even refinancing debt.
In 2020, SBA loans make the bulk of all business loans as for the total amount in dollars borrowed, followed by banks and online lenders.
SBA loans are still provided by banks or any lender who adhere to the program; they are also directly available through the federal site. They can offer below-market interest rates, especially for some subtypes, possibly lower than bank-offered: this is because lenders are covered by SBA for a broad part of the loan in case of borrowers’ default. However, an SBA loan requires narrow eligibility criteria, a longer qualification process, and binds you to use the funds in a strict way, resulting to be less flexible overall.
Besides, SBA loans will have a major upfront cost than non-SBA because of fees; in turn, they can give you access to higher amounts to borrow, and longer terms of repayment that you won’t find elsewhere. Among SBA loans, there are several subtypes available, differing in purposes, and according to conditions.
| Loan types | Interest rates | Maximum limit amount | Repayment maximum term |
|---|---|---|---|
| 7a loans | 7.5-10% | $5 million | 10 years for working capital (25 years for commercial real estate) |
| CDC/504 loans | 3.40-3.65% | $20 million | 10/20 years |
| Micro-loans | 8-13% | $50,000 | 6 years |
| CAP lines | 5-10% | $5 million | 10 years |
| Commercial real estate/equipment | 5-12% | $14/20 million | 25 years |
| Disaster loans | 4-8% | $2 million | 30 years |
- 7(a) loans are the classic and most pursued SBA loans, in fact, they are the most versatile and are especially suitable for working capital. They require at least a 10% down payment, which means shelling out 10% of the loan amount upfront, and possibly some collateral asset.
- CDC/504 loans are used to finance the purchase/rental or construction of land, building,s, and major equipment. They come with fixed rates, require 10% of the project amount to be covered with a down payment, and are secured.
- You can also obtain a line of credit through SBA if you plan to borrow multiple times instead of a lump sum once: this can be useful in a range of situations.
- Disaster loans are aimed to help business owners who have faced a calamity damaging or destroying the places and items of the business.
SBA can assure lenders with 75% or 85% of your loan respectively if you borrow more or less than $150,000: thus, there will be guarantee fees ranging from 0.25% to 3.75%, according to loan size and maturity date.
Here you can see a comparison of a 7a loan with non-SBA (bank) loans:
| SBA loan -7(a) served by a bank | Conventional bank loan | |
|---|---|---|
| Loan Amount | Up to $5 million | Depending on bank |
| Interest Rate | 5.5%-8% | 4-7% |
| Max term | 10 years | 5 years, variable |
| Allowed uses | Working capital, equipment, business acquisition | At the discretion of the bank |
| Business collateral | Fixed assets | Fixed and personal assets |
| Guaranty requirement | Personal guarantee | Depending on assets and loan length |
| Origination Fee | 0.5-3.5%; none if the loan is guaranteed. | Roughly1% |
A down payment of 10-20% of the loan amount is typically required in both cases.
For SBA 7(a) loans, there is always a daily “prime rate” decided by the Federal Reserve, while the remaining portion of interest is set by the lender, and can be fixed or variable. SBA loans are secured like most of the business loans, so that they will require a collateral asset, as well as a personal guarantee: if you couldn’t make the loan repayments, you would have to dispose of the agreed assets, being the buildings or equipment of the business.
A personal guarantee is a formal declaration that you anyway will be paying “personally”, instead of with the business proceeds, implying that you are legally liable for the business, that is the case where you are not its unique owner or play a major role; in general, it is likely to be asked when assets aren’t enough worthy.
On top of the origination fee, both SBA and non-SBA loans have a range of other fees that can add a few thousand to the cost of the loan: if and which they are applicable depends on the lender and your specific circumstances as a borrower.
SBA loans are intended and ideal for borrowers who couldn’t qualify for traditional bank loans, or have already exhausted the funds from other financing sources. If you have good to excellent credit, you are likely to find better rates and more freedom to manage the money from conventional lenders, such as online providers or banks; likewise, if you have a poorer score, you would at least find lenders who can at least approve the loan.
If you want a more slender process of getting the money you need, the choice is better addressed toward the several online lending companies, that will provide you with all the conditions to support your business if you can bear their higher, still affordable APRs.
How to get a business loan?
You can ask for a business loan from a bank or a private lending company. Through banks, it’s often difficult to get a loan, because of the high standards required to qualify; online lenders are more flexible and can overcome a few limits of banks. Not surprisingly, in the last decade, there has been an increasing demand for loans from these providers: they come with lesser strict requisites, such as a lower credit score, less paperwork, a time of approval possibly in a matter of hours, but charging with higher rates for taking the risk.
Among online choices, you can find different categories of lenders: direct servicers, peer-to-peer platforms that act as marketplaces where borrowers and private lenders meet, and brokers who work for multiple providers.
Depending on the lender of your choice, you may opt for a fixed or variable interest, different repayment schedules, to secure or not your loan. Every lending company will assess your previous and present career, existing debts and might also want to consider if your business is viable, that is why you could be asked for a business plan.
You are more likely to obtain a loan from a bank if you have an established business with a big annual revenue, whereas you need larger amounts of money to borrow, that might not be granted from other lenders; moreover, in such case, you would have a better credit score than a fresh business owner, so to qualify for lower rates. On the other hand, a bank won’t allow so easily a business loan if you have a low credit rating, are new to the business, and/or your revenue is relatively low.
It is generally recommended to find by yourself what your current credit score is so that you know which offer you can apply for. Other things that lenders will consider are the time of activity of your business (as an index of its survival rate) combined with revenue which, of course, is a crucial factor: it is not likely that a lender allows you to borrow the money you can’t pay back, so that will affect your maximum loan amount.
What business loans are available?
Following, you can see the main of the several types of business loans existing:
- Term loans: also referred to as small business loans
- Business lines of credit
- Short-term loans
- SBA loans
- Interest-only loans: you pay the interest portion only during the loan lifetime, then at the end date you owe the principal balance in a lump sum
- Merchant cash advances/credit cards factoring loans: you receive an amount that is repaid with a fixed percentage of your credit and debit card future sales, so repayments size will depend on the performance of the business, and are deducted daily with an applied interest that is named “factor rate”.
- Equipment financing
- Invoice/accounts receivable factoring: you obtain a lump sum by selling your unpaid invoices to a factor, with a discount; the factor is then automatically repaid from its customers. So, it is a means to get cash quickly, but actually a trade-in rather than a true loan.
- Business credit cards
Each of these serves a specific function or purpose of the business and will have according to rates, terms, and amounts along with their own perks. If, for example, your operations required to be frequently financed, or you just have to manage a constant cash flow, then you would opt for a line of credit instead of, say, a short-term loan of a lump sum.
“Interest-only” loans can be ideal to leverage your investment in the short term, with a business rapid growth in perspective.
For financing a fresh business, you may want to business credit cards, which give you easier access to cash and rewards.
Most business loans require that repayments are made on a monthly basis, while others impose a weekly or daily schedule. They will also vary greatly as for APRs: for instance, a line of credit APR can be in the range of 8- 80%, and merchant cash advances up to a big 250%. Because of such rates, one can easily get into debt, so loan sustainability must be carefully evaluated in proportion to one’s need from time to time.
Top online lenders, like the ones we present, can offer the complete plethora of these products.
How do you qualify for a business loan?
In order to be qualified then approved for a business loan, lenders will look essentially at three factors: your credit history, which is reflected by the credit score, your current (or a reasonable foreseen) revenue, and time in business. In the case of start-up businesses, since there is no proven income, they are considered risky, thus more likely to be not approved; however, there are varied offers that are tailored for start-up, coming typically with higher rates. In general, the longer the period you are in business, the more options you will have.
Different lenders will diverge in how much they consider relevant each factor, thus you will find differing “numbers”. According to Federal Reserve, industry standards for a bank require that you have at least 2 years of documented business history (unless you are a start-up), with annual revenue of $250,000; an online lending company instead, generally want you in business for 1 year with $100,000 of profit as a minimum, while some lenders can “tolerate” a yearly income as low as $50,000.
| Banks | Alternative lenders | |
|---|---|---|
| MINIMUM CREDIT SCORE | 680 | 500 |
| ANNUAL REVENUE | $250,000 at least | Starting from $50,000 |
| AGE OF BUSINESS | 2+ years | Start-ups allowed |
| PROFIT AND LOSS STATEMENT | Yes | Depending on lender |
In most cases, how much you can borrow is calculated as a small percentage of your annual revenue, so that lender is safe about your ability to repay. If you are a startup, you will have access to a lower maximum limit compared to what existing businesses would, and again, interest rates tend to be higher. Most lenders, including those who operate through SBA, provide loans for startups.
You can be denied for a business loan basically if you are supposed to be unable to repay: this might be due to a low credit score, a poor credit history, amount of pending debt, low performance of your business, or not having enough assets that can be used as collateral. Improving each of these conditions will give you a chance to obtain the loan in the future: this involves striving for a few periods until your business grows naturally and making sure that you are regular with other payments you have.
Securing a loan can be a way to get qualified, whereas it wouldn’t be possible, or still to obtain a more affordable rate.
Can You Get a Small-Business Loan With Bad Credit?
Loans that are suitable for business owners with a bad credit score are certainly available, but options are more limited. Most, if every lender and loan programs have minimum credit score requirements: some of them can accept a score below 630 down to 500, by offering higher interest rates and smaller amounts to borrow than one can be allowed to with a better financial status. In such a case, you will also have to provide more information about your job history and business, including how do you plan to make a certain revenue.
If instead, you have a rating less than 500, you are very likely to be ineligible for a conventional business loan: you may still be able to get merchant cash advances or a little range of business credit cards, otherwise, you would rely on alternative, risk-averse sources of financing, such as the discussed grants or angel investors.
The better thing to do in case of bad credit is taking your time and making the effort to improve it, that is to say, basically paying off or consolidating existing debts, removing too many lines of credit, or increasing your income. Other moves you may want to consider are:
• Using collateral. This includes a personal asset, or better, business assets like equipment, unpaid invoices, and accounts. While it would be even possible to use your home equity, that cannot be recommended because of the high risk.
• Adding a co-signer. A trusted individual who is willing to use his/her credit score, which must be at least a good one, and will be liable in case you are not able to make the repayments.
• Asking a realistic amount for your budget, such as with microloans. The less you borrow, the more the chances that your loan can be repaid entirely, even with sub-optimal financial conditions.
• Finding peer-to-peer lenders who are prepared to take the risk. They are private servicers, so this is a more flexible option since various conditions of the loan are more negotiable than with companies or banks.
How do you apply for a business loan?
It can be done in person or, more comfortably, online through user-friendly forms. When done through banks, the whole process is usually longer and more detailed, while online lenders ask for less paperwork and allow a more straightforward process overall. Regardless of the source, you will have to expose some essential mandatory information, and exhibit the following documents:
- Any valid ID, including passport or driver license
- Bank statements related to the business
- Profit and loss statements
- Tax returns
- Business plan, in some cases
All these are meant to make your lender know about you and your job and to ensure that you are in an ideal financial position to borrow a certain amount of money for a given rate, as well as keeping up with the repayments.
How much are small business loans average APRs?
A small business will be considered riskier than medium and big-sized ones, and this will reflect in prospective APRs. That said, a common small business or “term loan” has APRs in the range of 8-12% from online lenders, and of 6-10% for an SBA loan. If one has a good credit score along with an optimal financial profile, he/she can obtain a bank loan with rates of 4-6%.
Which business loan is best?
When it comes to borrow and manage money, knowledge is key. Financial matters can be a headache for most, still, it is your full responsibility to know what there is on the market. You should previously do simple math to determine a monthly budget, that will be aimed at repayments: without the right calculations, embarking on a business loan might be severely harmful to your finances, because you also have other expenses such as a mortgage, insurance, etc.
So, when choosing a business loan you must first and foremost consider its APR: it will determine the overall cost and affordability of the loan. However, the lowest APR isn’t necessarily the best choice: along with it, you have to look at things like additional costs, loan term, and repayment modalities, down payment/collateral requirement, minimum eligibility criteria, maximum amount borrowable, timing to obtain funds since application, allowed use of the loan, and customer reviews of the lender. You will have to find the right compromise that fits your needs at best.
Most lenders make pre-qualifying or pre-approving offers, depending on the extent of personal details you are sharing: in the first case, it may be sufficient a call, while pre-approval requires documentation. Requesting a quote from them will result in an outcome, that is more accurate with a pre-approval: this means that before the final application you will have at least more information about how much you are eligible to borrow, and under which rate., giving you the power to decide which lender has actually the best deal.
Advertised rates are starting points to determine your final applicable rate, which will depend on your individual factors. No wonder that you find APR expressed in ranges, where you can clearly see how much they can differ not only among lenders but as for every single offer.
Setting autopayments is encouraged, and makes you save money because APRs will be discounted as a practice of many lenders; if you already had an account with those banks or private you may be eligible for lower rates or reduced fees.
According to our research, to follow are the best business loan companies for bad credit:
– BlueVine: for borrowers with FICO credit scores as low as 530
– Kabbage: for alternative qualification requirements
– OnDeck: for borrowers with FICO credit scores as low as 600.