Every entrepreneur knows how difficult it is to start your own business and get the first business loan. And most of them are aware of the fact that keeping that business afloat is an even more difficult task. Unfortunately, over half of new small businesses fail within the first 5 years, mostly due to the lack of funding.
If you don’t want to become a part of this statistic, you need to ensure you have the means to stay in business. The best way to do this is by applying for a small business loan.
Keep in mind that small business loans are nothing to be taken for granted, and you need to be very responsible and do your research before applying for them. So, take a look at this overview of small business loans to learn the fundamentals and stay in the know.
What is a Small Business Loan?
If you’ve ever taken out a personal loan, a mortgage, or at least used a credit card, you probably have some basic understanding of how borrowing money works. You’ll need to (a) apply for a line of credit, (b) get approved, and (c) pay back the money within a specified time period. At their core, small business loans work essentially the same way.
If you and your business meet the lender’s requirements, you can quickly get the cash you need to keep your business afloat. The money can be used for any type of business expenses you have, payroll, inventory, equipment, even marketing.
Secured Vs. Unsecured Small Business Loan
When opting for a small business loan, the first thing that you’ll need to consider is whether you’ll be applying for a secured or unsecured loan.
As always, unsecured business loans come with (a) stricter requirements, (b) higher fees, (c) higher interest rates, and (d) lower limits. This is all because unsecured loans are riskier for the lenders. There’s no collateral that they can seize in case you don’t pay off your loans nor security deposits that they can keep.
Secured business loans are typically better for both the lender and the borrower. The lenders can collect your deposit/collateral in case you’re not paying your loans back, so you will have (a) more flexibility, (b) lower rates and fees, (c) higher limits, and overall (d) better terms and conditions.
In case your business doesn’t have any assets or properties that can be listed as collateral, many lenders will allow you to use your personal property to secure the business loan. While this might not sound ideal, as long as you’re diligent with your loans and debts, you shouldn’t have anything to worry about.
7 Types of Small Business Loan Offers
Depending on your current financial situation and business needs, you can choose from a variety of different types of small business loans. It’s crucial that you take enough time and consider your choices very carefully, as different loans come with different limits and overall terms and conditions.
Listed below are some of the most popular 7 types of small business loans.
Microloans can be ideal for new business owners, startups, and businesses in disadvantaged communities. As their name would suggest, these loans have very low limits and typically don’t go over $50,000. They’re not offered by banks or credit unions, but rather by non-profit organizations and individuals.
Microloans are a type of unsecured loan that comes at a lower cost. Your fees mostly depend on your credit score, previous borrowing behavior, and overall creditworthiness, and if you’re seen as a less risky borrower, your interest rates can be as low as 6%.
Another type of loan for a startup is a personal loan. Many banks and credit unions will reject loan applications from businesses with no operating history, so this might be your only option to get your new business off the ground.
Your loan limit, its rates, fees, and terms and conditions will depend entirely on your personal credit history and creditworthiness, and you’ll need to have a good or excellent credit score to be approved. The biggest downside is that you can harm your personal credit score if you don’t pay off your debts on time.
Businesses that are looking to expand can benefit from term loans. You can take a specific amount of money from a bank or credit union and agree to repay it within a specified time period. Your borrowing amount can be higher with term loans, although you will typically have to offer an asset such as a piece of real estate as collateral.
If your business has established a good credit history, you can get approved for a term loan in a matter of weeks, and immediately get your predetermined lump sum of money.
Small Business Administration (SBA) is a government agency that can get you the funding that you need to keep your business operational. Your loan will be backed by the government, which means that you can expect lower interest rates and fees, and more favorable terms and conditions.
This also means that the requirements will be stricter and that your business has to have a good credit history.
If you’re approved for an SBA loan, you can get a high borrowing amount of up to $5 million, and an excellent repayment period that can go from less than 10 years to up to 25 years.
Keep in mind that you will have to be patient with this loan, as it can take up to a few months to find out about the status of your application.
Business Credit Cards
If you’re interested in a revolving line of credit for your business, you can apply for a business credit card. They operate the same way as personal credit cards. You will need to make minimum monthly payments. You’ll have a credit card limit, and you can collect rewards and bonuses, etc. Business credit cards can come with numerous fees, so always be sure to check the fine print of your credit card agreement before you sign.
These cards are the most beneficial if you have ongoing expenses such as utilities, travel, etc., and since they don’t require collateral – they can be a good option for business owners.
Business Line of Credit
If you need to deal with unexpected expenses or have short term financing needs, a business line of credit might be a good option for you. You will have a credit limit, but you’ll only be paying interest on the money that you’ve spent/drawn. It’s a similar option to term loans, but you’ll have more flexibility at a lower cost.
Speaking of the cost, there might be some unexpected fees with business lines of credit, so again, read the whole agreement and the pricing and information section before you sign anything.
The last type of small business loan that we’ll cover is the equipment loan. They serve to help new business owners buy the proper equipment they need. Normally, the expected lifespan of the equipment is what will set the loan term, and the equipment itself will serve as collateral in case you don’t pay your debts off in time. Your rates and fees for equipment loans will primarily depend on your business’s creditworthiness and the value of the equipment you’re buying.
This can be an excellent solution if you need to buy company cars, machineries, and or e.g. kitchen appliances for a restaurant, etc. Since you’ll own everything that you buy, you can build your business around the equipment.
As you can see, depending on your needs, you can find a wide variety of small business loan offers that can suit you.
Small Business Loan Lenders
Small business owners can find loans from a few different lenders:
- Banks/credit unions
- Alternative sources
A loan from a bank will normally carry a lower interest rate, and you’ll be able to find out pretty quickly whether or not you’ll get approved. Most business owners get an answer within 2 weeks. The problem here is that banks have higher requirements for their applicants and approve only about 20% of all applications.
An SBA loan has its own pros and cons. Being a government agency, SBA offers several loan programs, has favorable terms for the borrowers, and is a safer bet for the lenders. Of course, as with anything that’s government-related, you’ll need a lot of paperwork, and the whole approval process is much longer.
You can also try and apply for a small business loan online. These alternative lenders don’t require you to have an excellent credit score or an impeccable financial history. They do have a lower maximum amount that you can borrow and can come with some hefty fees and interest rates. Always read the fine print of your loan agreements before signing them.
Application Requirements for a Small Business Loan
Just as with any other type of loan or credit, the exact application requirements will vary from lender to lender. Some will allow you to get a small business loan with a poor credit history, and others will just require you to have a longer business financial history.
As a general rule of thumb, you’ll need to provide the following information when you’re applying for a small business loan:
- Personal credit history
- Income tax returns
- Business overview
- Profits and losses statements
- Proof of ownership
- Business financial statements
You might be required to provide additional information, so to stay on the safe side, it’s always best to keep all your financial documents on hand when you’re applying for your small business loan.
Small Business Loan Offers Recap
Small Business Loans Frequently Asked Questions
Both secured and unsecured loans can be a good choice for a small business owner, and this depends on what you need the loan for, and how you plan to repay it. A secured small business loan will often get you better terms and conditions, and a higher maximum limit. The downside is that you will need to list an asset such as real estate as collateral.
An unsecured business loan will often have a lower limit, higher interest rates, higher fees, stricter application requirements, but you won’t have to list any collateral.
Related Read: CowerWallet Commercial Business Insurance Review
The maximum amount for a small business loan will depend entirely on the lender itself. Small Business Administration offers maximum loans of $5 million, but you might not be eligible for this amount. You’ll need to keep in mind that different loan-types will also have different maximum amounts. The maximum amount for a microloan, for example, is approximately $50,000.
Of course, your creditworthiness, and the overall financial history of your business will also be important factors that will influence the lender’s decision about the maximum loan amount that you’re eligible for.
Related Read: Government Support for Small Business (COVID-19)
Yes, if you cannot get approved for a small business loan, you can apply for a personal loan and use it to cover your business expenses. Since you’re likely to need a bigger loan for your business, you’ll need to have an excellent credit score to get approved.
Keep in mind that you will be putting your personal credit history at risk if you fail to make your payments on time, so be careful when taking out a personal loan for your business.
Check Business Insurance, too.
The application requirements will differ from lender to lender and from loan-type to loan-type. Generally speaking, you will have to have a good personal credit history, and for the most favorable loans, you will need a strong business with a great credit score.
Some of the necessary paperwork that you’ll probably need to provide includes (but is not limited to):
- Personal credit history
- Income tax returns (See Offers)
- Business overview
- Profits and losses statements
- Proof of ownership
- Business financial statements
There are many different types of small business loans, but unfortunately, there isn’t a single type of loan that stands out from the rest. The best type of loan for you will depend entirely on your needs and the overall financial situation of your business.
If you simply need money to cover the expenses of your business equipment, an equipment loan would probably be considered the best. A business credit card might be the best choice if you want revolving credit to cover some common expenses. As you can see, different loans are designed for different purposes, and you will need to determine the best loan for yourself.
Interest rates on small business loans can vary greatly, and many factors will be used to determine the rates that you’re offered. Primarily, the rates will depend on the lender. Normally, government-backed loans will have more favorable interest rates. From the SBA, you can expect interest rates from 6% if you have excellent credit history and a strong business, and they can go to over 30% with Bad credit history.
Banks offer slightly less favorable rates, while alternative lenders often impose the highest rates since they take on the greatest risk. You will have to talk to a few different lenders to find out what kind of rates you can expect.
According to the Federal Reserve, the average loan amount for a small business is $633,000. This number takes into account only the conventional bank loans and leaves out the average amount for SBA or alternative lenders.
Either way, this number can work as an estimate of what you can expect to get when you apply for your own loan. Depending on your personal credit score, your business’s financial history, and your overall situation, you might get approved for a much lower limit, or even a much higher one.
The length of your application process is often very uncertain. If you need cash quickly, you might want to consider applying for a loan from an alternative lender online. Many online lenders offer instant decisions that let you know whether you’ve been approved for a loan or not immediately.
Banks will take at least 2 weeks to let you know about your application status, and sometimes you’ll have to wait a bit longer. If you apply for a government-backed loan, be prepared to wait for a while. It can take up to several months to find out whether you’ve been approved for a government-backed loan.