Business loans help to keep many companies afloat in tough times and provide additional financing for expansion and improvement. Lenders across the nation provide many types of loans to help meet this need, each of which varies according to your needs and the capabilities of the lender.
But just how do business loans work? And is this option a good choice for you? Let’s take a deep dive into this subject to learn more! By the time you’re done, you should have a pretty good idea not only of what types of loans are best for you but whether you should even apply for a loan at all.
How Do Business Loans Work?
Business loans follow a pretty similar arch to traditional loans. First, you need to apply for the loan (including preparing all of the essential paperwork. Then, it would be best if you worked with the lender to set up your repayment terms. Finally, after everything is properly sorted out, you can get your money and use it.
The repayment cycle is critical to understand because it can affect your business operation. Multiple repayment methods make this process easier to finish. Just as importantly, you need to pick a lender who understands you and who is willing to work with you to minimize confusion or frustration.
Applying for a Business Loan
When you’re trying to apply for a business loan, you need to start by making sure that you qualify. Your lender will walk you through these steps and make them easier to understand. But, just as importantly, they can check all of your documentation, work with your financial officers, and minimize your potential risk of errors. In this way, you can get the loan that you want at a reasonable price.
Check Your Credit Scores
Lenders typically examine your credit score before they provide you with a loan. They usually focus on business credit scores but may look at your personal credit score as well (see the FAQ to learn more). They start by using a credit reporting agency to see where your score sits. Most want a score of at least 700-800 before they approve a loan. The higher your credit score, the better your loan terms.
If possible, you may want to take the time to improve your credit score. This step should take place over about 6-12 months or longer to get the best results. Do things like pay your bills on time, pay off high debt, and take other steps to boost your score. If possible, you should try to pay off all your debts before getting a loan. Doing so dramatically increases your chances of getting a better credit score.
Pay Attention to the Requirements
Research the different requirements that each lender demands before you apply. Doing so cuts back on your risk of applying for a loan that is not right for you. It also decreases your risk of errors and much more. Just a few steps that you likely need to take include how you should:
- Keep Your Credit Score Above the Mid 600s – While you might qualify for a loan at 640, your rates and terms will not be significant. So do what you can to improve your credit result
- Provide Proper Documentations – Showcase the various legal and financial documents necessary, including a voided business check, bank statements, profit and loss statements, and tax returns
- Develop a Business Plan – Your business plan must be an in-depth examination of how you plan on using the loan money to become more profitable. Detail is critical here!
- Include Various Important Data – Bring your bank account statements, personal financial information, a business balance sheet, and anything else your loan requires.
- Provide Collateral – If you’re taking out an SBA-backed loan, you must give a collateral and a personal guarantee worth at least 20% of your business. Not all business loans require this step
After you’ve gathered all of this information, you can use it to help focus your loan process. For example, before moving onto the next section (where we’ll discuss business loan types), we went to touch on how to create a business plan. Though we can’t write about this step in detail, we can give you an idea of what you’ll need to include, helping to focus your loan application process.
Creating a Business Plan
Making up a business plan when applying for a loan is often a challenging process. We could write a whole article on these steps alone! As a result, we’re only going to lightly touch on what you need to do to produce one of these plans. You’ll typically need a handful of different elements, including:
- Brief business description
- Product or service description
- Market analysis about your business
- The names of your management team
- Marketing and sales strategies
- Financial plans and possible futures
Once you have gathered all of this information, you can usually apply for one of the many business loan types available for your company. These will vary based on many different factors. Make sure to read through the next section carefully to get the best results when taking out a loan.
The Many Types of Business Loans
When you’re choosing a business loan, you usually have four different available options. Choosing one that makes sense for your needs requires you to research your options and take the time to ensure that they meet your needs. They include:
Term Business Loan – This type is probably the most common you’re likely to find. A term business loan is a good choice if you need money right away and want to upgrade your company. They set up a set time for repayment (usually between 5-10 years, at the most), during which you need to make payments to keep the loan from defaulting. These payments vary based on your credit and capital
Short-Term Business Loan– A short-term business loan may be a good alternative if you’re in a challenging situation and need immediate cash. They are usually available for low-credit companies but must be repaid between 30-90 days. Most have high-interest rates and should only be considered if you do not qualify for a term business loan or other types of less-costly financing.
Invoice Financing– Did you just finish a project or provide a service but haven’t been paid? This situation is frustrating and can become troublesome if you need cash. Invoice financing uses the payment on this project as the collateral for your loan. Most common for contractors who need to cover quick expenses, this option usually requires an immediate payment turnaround
SBA Loans– The Small Business Association (SBA) underwrites lender loans to help guarantee the loan up to a certain percentage. This option is an excellent way to get fair interest rates and minimize your payments. However, you only receive them if you qualify as a small business. Larger companies do not get these loans because they usually more easily qualify for term loans instead
Equipment Financing– Are you looking to pay for expensive equipment and need a loan? This option is probably your best choice. Explicitly designed for buying and installing equipment, you must show the lender how you plan to use the equipment and how it will improve your finances and success. Repayment loans usually last many years: you lose the equipment if you default, though