Tips for Comparing Small Business Loans
Consider these tips when comparing small business loans:
Where possible, prequalify. Some business financing lenders offer a prequalification process. This means prospective borrowers can share details about their financing needs, revenue and other relevant information to find out what loan amounts, rates and repayment terms they may qualify for. This process typically only requires a soft credit inquiry, which has no impact on your credit score.
Determine how you want to receive your funds. Two of the most common ways you can receive and access your business funds are through a lump-sum payment or on an as-needed basis. If you want to receive your funds up front, choose a traditional working capital or term loan. However, if you want to use funds only as you need them, consider a business line of credit.
Consider the repayment terms and flexibility. Each business financing lender has its own repayment structures. While some types of financing require monthly payments, others may require daily or weekly payments. Take this into account when choosing your preferred lender and business loan.
Look out for additional fees. Some lenders offer fee-free business loans that don’t require borrowers to pay origination fees, late payment fees, prepayment penalties or any other common loan costs. However, this is not always the case. Be sure to confirm a lender’s fee structure when shopping for the best terms. Factor in additional fees into your decision-making process.
Evaluate the lender’s customer support options. If you’ve found a lender that’s prepared to offer the money you need at acceptable terms, consider the lender’s support options before signing the loan agreement. Customer support can make a huge difference down the line if you encounter issues with repayment. Research the lender’s customer service resources and read reviews to make sure it’s a good fit.
How Do Small Business Loans Work?
Small business loans help companies make large purchases and cover the cost of doing business. Loans generally are issued as a lump sum that can be used to make a specific purchase or manage cash flow and then repaid with interest. However, there are other types of small business loans—like lines of credit, merchant cash advances and invoice financing—that can be used to access cash more quickly and on an as-needed basis. The best loan for a business depends on a number of factors, including its creditworthiness, how much it needs to borrow, what the funds will be used for and how quickly it needs access to loan proceeds.
Small Business Loan Types In general, small business loans help businesses access the money they need to operate and grow. However, there are several types of small business loans, and it’s important to find the best fit for your needs. SBA Loans
SBA loans are small business loans that are guaranteed by the Small Business Administration, including the SBA 7(a), 504, CAPLines, Export, Micro loan and Disaster loan programs. These loans typically range from $30,000 to $5 million and come with low interest rates and extended repayment terms—up to 25 years. That said, qualification requirements are more demanding than for other loans not backed by the government, and the application process typically takes longer. Common types of SBA loans include:
SBA 7(a) loans. With maximum loan amounts up to $5 million, the SBA 7(a) loan program is the SBA’s main offering. Loans are commonly used to purchase real estate but may also be used for working capital, debt refinancing and the purchase of business supplies. Current interest rates, as of Oct. 7, for SBA 7(a) loans range from 5.5% to 11.25%.
SBA 504 loans. Available up to $5 million, SBA 504 loans must be used for major fixed assets, like existing buildings or land, new facilities and long-term machinery and equipment. As such, 504 loans may not be used for working capital, inventory or other common business uses. Rates on SBA 504 loans are lower than those imposed by the 7(a) program, and range from about 2.81% to 4%.
SBA microloans. SBA microloans extend up to $50,000 and are intended to help small businesses start or grow. This may involve using the funds for working capital, inventory, machinery, equipment and other fixtures and supplies needed to do business. Rates typically range from 8% to 13%, but this varies by lender.
Term Loans Terms loans are a traditional form of financing that’s repaid over a set period of time. In general, short-term loans range from just three to 18 months, whereas long-term business loans may be extended for up to 10 years. While some term loans are designed for specific uses—like financing equipment or inventory—term loans traditionally can be used to fund most large business-related purchases. Business term loans are typically available up to around $500,000, and annual percentage rates (APRs) start around 9%. Lines of Credit Unlike a term loan that’s paid out in a lump sum, a business line of credit is a set amount of money that a business owner can access on a revolving basis. This means the borrower can draw against the line of credit for a set period of time—usually up to five years. If the borrower pays back a portion of the line of credit early, they can access it again until the draw period ends. Once the draw period is over, the borrower enters the repayment period and can no longer access the revolving funds. Rather than pay interest on the entire amount, as with a term loan, a business owner who accesses a line of credit is only charged interest for what they actually use. Lines of credit are a good option for businesses that want to access cash on an as-needed basis for things like unexpected expenses and other cash-flow issues. Borrowing limits generally range from $2,000 to $250,000 and come with APRs from 10% to 99%. Invoice Factoring and Financing Invoice factoring is the process of selling a business’ outstanding invoices in exchange for a lump sum cash payment. Invoices are sold to a third-party factoring company at a discount, so you won’t get paid for invoices in full. And, once you sell an invoice to a factoring company, the factoring company assumes responsibility for collections. However, this form of financing can be an effective way to access cash quickly without having to wait the 30 to 90 days customers usually have to pay invoices. For that reason, invoice factoring is a helpful strategy when you need short-term financing or help managing cash flow. In general, invoice financing amounts can extend up to $5 million with APRs between 10% and 79%. Merchant Cash Advances Merchant cash advances (MCAs) let business owners access a lump sum of cash by giving the lender—often a merchant services company—a portion of future sales receipts. In contrast to a traditional business loan, a merchant cash advance and related fees are repaid from the business’ individual sales or through automatic clearing house (ACH) payments on a daily or weekly basis. Under this strategy, a business owner borrows a set amount of cash at a factor rate usually between 1.2 and 1.5. To repay the loan, the business must repay the advance with a set percentage of daily credit card sales over an estimated repayment term. A merchant cash advance may be a good option for businesses that experience a high volume of sales and need to access cash quickly—without qualifying for a traditional business loan. Equipment Financing Equipment financing is a form of small business loan that helps businesses purchase the equipment and machinery needed to start and maintain operations. This flexible financing can typically be used for everything from office furniture and electronics to manufacturing equipment. Equipment loans are collateralized by the items being purchased, so the size of a loan depends on the value of the equipment and the size of the down payment. However, the best equipment financing companies offer terms and limits of up to 25 years and $1 million or more. Interest rates on equipment financing may be lower than available through other types of financing and typically range from 8% to 30%. As with other small business loans, rates vary by lender and borrower creditworthiness.
How to Get a Small Business Loan The business loan application and underwriting process varies by lender, but most banks and lenders follow the same general guidelines. To get a small business loan, expect to follow these general steps:
Determine the type of loan you need. Some lenders limit what industries they’ll finance or how loan funds may be used, so determine how you’ll use the cash before applying for a loan. Also evaluate how much you need to borrow, as this may impact the type of loan you apply for and the best lenders to approach for funds.
Familiarize yourself with your credit profile. Lenders typically look at a business owner’s personal credit score when evaluating a loan application. You should have a score of at least 680 to qualify for an SBA loan or a traditional bank loan, and 630 for equipment financing or business lines of credit. Short-term financing and merchant cash advances typically have less stringent requirements—averaging around 600 and 550, respectively.
Research lenders. When shopping for a small business loan, determine whether your current bank offers small business loans that meet your needs. This can streamline the application process because the bank will already have your financial information on file. Next, research other banks, credit unions and online lenders to compare available loan amounts, repayment terms and rates.
Gather required documentation. Required documentation varies by lender. However, most lending institutions require a business plan, at least 12 months of personal and business bank statements, tax returns for at least two years and details about any current and past business loans. Lenders also require copies of applicable business licenses and legal documents, details about available collateral and a description of how loan proceeds will be used.
Submit a formal loan application. Once you research the best small business loans and prepare your business for due diligence, submit a formal loan application. The process varies by lender, so familiarize yourself with the application process and contact customer service with questions.
Related: Business Loan Requirements: How To Get The Financing You Need
Requirements for Small Business Loans The requirements for small business loans can vary by lender. But in general, lenders may review the following information to approve you for a loan:
Personal credit. You may be able to qualify for a business loan with a credit score as low as 500. However, a good score of at least 670 could give you a better shot at getting approved for a competitive rate.
Time in business. Lenders typically require that you be in business for at least six months to two years to qualify for a loan.
Business checking accounts. Lenders may require that you have a business checking account with several months of transactions to show cash flow.
Business revenue. Most lenders require that you have between $100,000 to $250,000 annual business revenue to qualify.
How to Choose a Small Business Loan Just as certain types of loans are more appropriate for certain businesses, some lenders may be better suited to your business than others. Consider these factors to choose a small business loan:
Lender reputation. Check online reviews so you’re aware of any red flags or potential issues before you sign on the dotted line. If you plan to work with a local bank or credit union, check with other local business owners to see which institutions have the best reputation.
Qualification requirements. Most small business loans are underwritten based on the business owner’s personal credit score and are personally guaranteed. The minimum credit score required to qualify for a small business loan depends on the lender and the type of loan. So, it’s generally a good idea to check your personal credit score and then research each lender to compare minimum credit score requirements.
Available loan amounts. Loan amounts vary by lender and loan type. Before choosing a small business lender, evaluate your business’ borrowing needs and shop for a loan that fits those parameters.
Underwriting and funding speed. The amount of time it takes to process an application and receive funds varies widely by lender and loan type. In general, it can take anywhere from a couple of days (in the case of a merchant cash advance) to several months (for an SBA loan) to receive funds after submitting an application. If you need a loan quickly, choose a loan type and lender that can meet those time constraints.
Annual percentage rate. APRs also vary by loan type and lender, but generally range anywhere from 5% to 99%. The most creditworthy applicants qualify for the lowest rates, but some lenders are more competitive than others.
Additional costs. Many lenders charge origination fees that cover the costs of processing applications and underwriting loans. Likewise, some lenders charge prepayment penalties for borrowers who opt to pay off their loans early, while others charge draw fees on lines of credit. However, borrowers should not be charged application fees, and any fees levied prior to loan approval are a red flag.
Where Can You Get a Small Business Loan? Small business loans are available from a variety of traditional banks and credit unions as well as online lenders. However, each lender is limited by its own financial products and lending requirements.
Banks & Credit Unions Traditional banks and credit unions typically offer a limited range of small business loans, including those backed by the SBA. While traditional banks often have tighter borrowing standards than online lenders, small business owners may still find it easier to qualify at an institution where they have an existing banking relationship. Not only will the bank already have the business’ financial statements on file, but it may also be easier to get approved with a local lender who is familiar with your operation.
Online Lenders In general, online lenders may have more flexible borrower qualifications than larger, traditional banks. And, while APRs may be higher through online banks than traditional lenders, approval rates also are higher and borrowers are less likely to need collateral. What’s more, many online lenders provide faster funding speeds than their brick-and-mortar counterparts, making them a good option for businesses that need cash quickly.
Charles L Green
CEO & Founder of Main Source Lending