How small business loans work and what you need to know
Many entrepreneurs are apprehensive when it comes to small business loans. They view securing loans as a frustrating and complicated process that someone only considers when desperate. However, business owners should know how loans work and how borrowers can get them, as loans give an entrepreneur access to additional capital that he can use for his business.
How small business loans work
Generally speaking, small business loans work as follows: The borrower submits a loan application and other requirements to the lender. The lender then evaluates the submission based on certain criteria and decides whether to approve or decline the loan. If approved, the borrower receives the requested funding. He must then pay back the money plus interest through regular repayments over an agreed-upon time period.
The specifics depend on the kind of loan, so let’s take a closer look at some of the common types of business loans.
With a conventional business loan, you can borrow a large amount (from $25,000 to $500,000) and you pay monthly payments over a relatively long period, such as one to five years. The interest rate is also relatively low, as low as 7%.
Compared to traditional business loans, short-term loans offer smaller loan amounts (from $2,500 to $250,000), a much shorter repayment period (3 to 18 months), and a much higher interest rate (10% and above).
SBA loans, meanwhile, are affordable long-term bank loans partially backed by the Small Business Administration. Because they are partly guaranteed by the government, there is less risk for lenders and borrowers thus get better terms, such as longer repayment terms (5 to 25 years), higher loan amounts (up to $5 million), and interest rates as low as 6.5%.
With a merchant cash advance, on the other hand, you get a sum of money as an advance, then the lender takes a certain percentage of your daily credit card revenue until the advance and the interest are paid in full.
Some things you should know
- Different types of loans have different minimum requirements that the borrower must meet in order to be eligible. They also require different documents to be submitted during application.
- Some loans are harder to get than others but their better terms make them worth the trouble. A traditional bank loan, for example, is harder to qualify for than a merchant cash advance, but it offers a much lower interest rate. SBA loans, meanwhile, offer the best terms but also have the highest requirements and involve a lot of paperwork.
- Your options when choosing what kind of small business loan to get depend on multiple factors, such as how long you have been in business, your business revenues, personal and business credit scores, and available collateral.
- When it comes to bank loans, the road to getting your much-needed funding may be long and arduous, so you need to be patient. Many small business owners often need to apply to more than one bank and submit additional documents before getting approved.
- In case of rejection, keep in mind that just because one lender turned you down doesn’t mean that all lenders will, so just stay calm and polite. Figure out or ask why you were rejected and, more importantly, learn from the experience and address the issue(s) to increase your odds of securing a loan in the future.
- In general, smaller banks are more flexible in their loan requirements and are more willing to help out smaller customers, so if you want a bank loan but are having a hard time securing one from the major banks, try a smaller one.
Getting a business loan is not always easy but when done right, it can make a big impact on the success of your small business. Now that you have a better idea on how business loans work, you can make a more informed decision when securing funding for your company.