If you’re looking to start or expand your business, you’ll likely need a small loan. Business loans, often offered by banks, can help small businesses cover their costs. However, many people find it challenging to get approved. It’s crucial to follow these tips and information when applying for a business loan, as they can help you get approved faster.
Types of Loans Available to Small Businesses
Here are some common business loan types to consider when looking for financing options:
1. Business Term Loans
A traditional term loan offered by financial institutions works similarly to a personal loan. Businesses often seek this type of loan when they require funds for major purchases, upgrades, acquisitions, or other important needs. These loans are usually fixed-rate, and the lender will require a payment schedule of monthly or quarterly payments. The loans have a set end date. Intermediate-term loans are for three years or less, while long-term loans can last up to 10 years.
2. Line of Credit
Consider a line of business credit similar to a credit card. Your small business can borrow money up to a specific amount from the bank if approved, and you pay interest only on the amount you have used. This option offers flexibility, as you can use the money as long as you don’t exceed the credit limit. It’s a great option for small business owners with a regular income stream, a good credit rating, and assets they are willing to use as collateral.
3. Commercial Mortgage
A commercial mortgage can be used to purchase a new location for your business. It is secured by a lien placed on commercial property, similar to a residential mortgage. If your credit history is poor or non-existent, a bank may require the business owner or principals to personally guarantee the loan, promising to pay the debt if the business fails. Commercial mortgages generally have shorter terms than residential mortgages, which are typically 30 years.
4. Equipment Lease
Like leasing a vehicle, an equipment lease spreads the cost of major equipment purchases over a specified period. Lessors typically do not require a large down payment for a lease. At the end of the lease, you can return the equipment or pay for its remaining value based on its life and depreciation. While monthly payments are lower than purchasing the equipment outright, interest will increase the overall cost.
5. Letter of Credit
A letter of credit is a guarantee that the seller will be paid on time. This guarantee comes in two forms: buyer protection and seller protection. If the buyer fails to make payments, the bank pays the seller. This is usually offered for international transactions. Sometimes, buyers pay for this type of letter in advance, similar to an escrow account. The seller receives a penalty, similar to a refund, as a way of protecting the buyer. These letters are provided by banks to companies that meet specific credit history or collateral criteria.
6. Unsecured Business Loan
An unsecured business loan does not require the borrower to provide collateral. Because of this, lenders typically charge higher Interest rate for business loan. Most often, this type of loan is provided by online or alternative lenders, though traditional banks may offer unsecured loans to existing customers. Unsecured business loans can be more challenging to obtain than other types of loans due to the lack of collateral. Because these loans are a higher risk for lenders, they are usually offered in the short term to reduce the lender’s risk.
How to Obtain a Business Loan from a Bank
Follow these steps to obtain the funding you need for your business:
1. Research to Find the Best Lender
Compare different factors of business loans to determine which one best suits your needs. Key factors include:
- Interest rates
- Fees such as origination fees
- Qualifying criteria, such as credit scores and sales volume
- Collateral requirements
- The speed at which you can receive funding
- Documentation requirements
2. Organize Your Finances
Ask your bank what information they will need to process your loan application based on the type of credit you’re seeking and the amount requested. At a minimum, you should have three years of personal and business tax returns, balance sheets, accounts payable aging reports, and inventory breakdowns.
3. Create a Business Plan
If you’re seeking a loan for a new startup, a business plan is essential. If you haven’t written one yet, you can use free resources like local Small Business Development Centers (SBDCs), SCORE, and Economic Development Centers to help you craft your plan.
4. Estimate the Amount You Need
Prepare detailed estimates of the purchase or work you want to finance before meeting with the loan officer. Lenders want to know that you’ve carefully considered your business goals, the amount of money you’ll need to achieve them, and how you intend to spend the funds. If you plan to buy machinery or open a new location, do the math to determine the costs. Also, calculate how repaying the loan will impact your budget in the future.
Conditions for Obtaining a Business Loan
It’s important to understand a bank’s requirements when applying for a loan. Each bank has its own application process—some allow online applications, while others still require paper forms. The preferred method of application may vary depending on the loan amount and type of loan you’re seeking.
Pay attention not only to how the bank prefers you to submit your loan application but also to what they require for approval. Before applying, consider the following factors:
- Credit Score: A high credit score shows that you are reliable in repaying debt. Your credit score can affect your loan terms and interest rates.
- Loan Purpose: Some loans have specific requirements for their use. For example, a lease is used for equipment, and a mortgage is used to purchase real estate.
- Collateral: If your credit score is not high enough, some lenders may accept valuable assets, such as real estate, as collateral. However, if you fail to meet the repayment terms, you risk losing your collateral, which the bank can sell to recover its losses.
- Cash Flow: Banks want to see that you have a consistent income stream. If you lack steady cash flow, lenders may hesitate to approve your loan. Most lenders require a certain level of revenue to even consider your application. You’ll also need to provide a cash flow history and well-researched projections of your business’s financial future.
Conclusion
A business loan is a vital step to start or expand your business. Understanding the types of loans, preparing your finances thoroughly, and meeting all the requirements will increase your chances of being approved. Research and choose the right lender. Create a solid business strategy and calculate your financial requirements. You’ll have the tools you need to get the funding that your business requires to grow if you plan carefully and pay attention to details.
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