Lenders provide companies with business loans as a sort of credit. Lenders want repayment of the principal with interest and fees in exchange for this money. Working capital loans often require the borrower to make monthly payments according to a defined schedule, although repayment terms and interest rates vary widely depending on the lender and your credentials.
Types of Business Loans and How They Work
Equipment Financing
When a business takes out a loan to pay for a specific piece of equipment, it is known as equipment financing. Equipment financing is a type of self-secured loan in which the equipment purchased with the loan money serves as security. Since the equipment financing is based on the equipment, the conditions of this type of loan will also be based on the equipment.
You may get a loan for up to 100% of the value of the piece of equipment your business requires with equipment financing. Furthermore, the length of your equipment financing loan will typically match the expected life of the equipment you purchase with the loan funds.
Finally, because the equipment is used as security, the lender will take on less risk by lending to you. As a result, your equipment financing rates will be correspondingly low, maybe as low as 8%.
Business Lines of Credit
Business lines of credit are based on a revolving credit line. The draw and payback periods are usually separated in the repayment process. You can utilize your available business line of credit, repay it, and use it again throughout the draw term.
Typically, you’ll have to make interest-only payments during this period. When that term finishes and the payback period begins, the existing debt will be amortized, and you won’t be able to draw on the credit line anymore.
Instead of requiring a plan to use a lump sum payment from an installment loan, this approach allows you to obtain finance whenever you need it. Most business lines of credit demand strong financials and a long history in the industry, but certain lenders may be ready to deal with younger entrepreneurs.
Invoice Financing
This type of business loan gives advance funding to entrepreneurs who are waiting on unpaid payments. You may get a loan for up to 90% of the value of your invoice with this type of business loan, and the invoice serves as collateral for the loan. The invoice factoring provider holds the remaining amount of the invoice in “reserve,” which will be released to you, minus costs when your customer pays the invoice in full.
You’ll also be able to acquire lower rates on your financings because the invoice itself secures invoice financing. Invoice finance rates are usually expressed as factor fees applied to the reserve amount kept by the financing business.
You’ll usually be charged a 3% origination cost (or advance fee) plus a 1% factor fee for each week your account is unpaid (charged on the principal). When your customer pays the invoice you financed, you’ll get the balance of the invoice less the origination and factor costs.
Term Loan
Long-term, intermediate-term, and short-term term loans are the three types of term loans you may encounter. Long-term and intermediate-term loans are generally standard bank loans that need at least two years of business experience and substantial income. The payback periods, which are calculated monthly, often vary from a few years to ten years.
In comparison to other types of business loans, long-term and intermediate-term loans often have lower interest rates. On the other hand, short-term loans could be offered to young business owners with little or no experience. These loans usually have a one-year repayment period and have hefty interest rates.
While it may be tempting to utilize a short-term loan for a temporary fix, think about the costs before applying. Term loans are available from banks, credit unions, and online lenders.
SBA Loans
SBA loans are long-term loans that are partially insured by a government agency known as the Small Business Administration. This implies that, when the SBA partially guarantees an SBA loan, it indicates that they will cover a portion of the loan amount received by a small business.
So, if a borrower is unable to repay an SBA loan, the SBA will reimburse the lender for the amount guaranteed. Lenders take on less risk by financing a small business because of this guarantee, and this reduced risk makes lenders more likely to lend to small businesses.
When they do lend to small businesses, they do it on more favorable terms, such as lower annual percentage rates, larger loan amounts, and longer payback terms. Indeed, SBA loans are the finest value on the small company loan market because of this partial guarantee. They can be anything from $5,000 to $5 million in value, with payback lengths ranging from 25 years to five years.
How Does Business Loan Repayment Work?
The type of business loan you select has an impact on how you repay the debt. Revolving, installment, and cash flow are the three basic types of business loan repayment alternatives.
Revolving
The two most common types of revolving business loans are business credit cards and lines of credit. You’ll obtain a line of credit when you create an account, which you may use anytime you need it. Your available credit decreases when you use your card or draw from your line of credit.
However, once you’ve paid back the money you borrowed, it becomes accessible credit again. You can borrow, repay, and re-borrow up to your credit limit as long as the account is open and during the draw period of a line of credit.
Installment
Installment loans make up the majority of business financing. Instead of a revolving credit line, you are given the entire loan amount upfront and must repay it in equal payments. In this manner, you’ll have a pre-determined payback period, usually with fixed monthly installments.
Cash flow
A cash flow-based business loan works in the same way as an installment loan in that you get the entire loan amount upfront. However, repayment depends on your financial flow rather than having a defined payback period. A merchant cash advance, for example, provides financing depending on your debit and credit card transactions.
You may be able to settle the debt by giving the lender a percentage of your future debit and credit card sales. With invoice financing, you may obtain funding based on an accounts receivable invoice, which you will return when the invoice is paid in cash.
How to Pick the Right Loan for Your Business
Small business owners may choose from a variety of small business loans, each of which works in a somewhat different way. To figure out which one is ideal for you, think about where your business stands. If you’re starting a business from scratch, you’ll only have a few alternatives, such as business credit cards and invoice financing.
If you’ve been in business for a while and have solid financials, you may be able to get whatever type of loan you want. Consider what you need from a loan when you examine different possibilities. Do you want a revolving line of credit or a one-time payment, for example? Do you want installment payments or payments dependent on your financial flow? Is it worth it to wait to borrow until you’re in a better financial situation, and how sensitive are you to interest rates?
It will be easy to limit your options if you analyze all of these criteria. Once you’ve decided which type of loan is best for you, take some time to evaluate several lenders who provide that loan. Shopping around will increase your chances of acquiring the best interest rate and conditions available because each lender has distinct creditworthiness standards and loan terms.
Conclusion
There is no definitive answer to this question. The answer to this question depends on your business and the type of business loan you want. So, once you’ve decided which type of loan is best for you, take some time to evaluate several lenders who provide that loan.
