When you’re ready for a business loan, a bit of homework beforehand makes the process easier for you and the loan officer. Walking in the door prepared helps them do a better job for you, providing key pieces of information and setting the foundation for a long-term banking relationship.
Lack of information results in a banker presenting you with the most common loan package, instead of a customized offer that considers your short- and long-term goals. It should never be only about how much money you qualify to borrow.
Understanding different types of loans is part of the due diligence process. It also helps you learn why interest rates are higher for certain high-risk types of loans.
SBA Loans – backed by a Small Business Administration (SBA) guarantee of payment but funded by bank lenders, SBA loans are typically easier to qualify for than a bank-funded loan. It can be a slow process to finalize the application and be funded, but terms range from five to twenty-five years for paying off the loan and are often readily available.
SBA loan interest rates are priced according to risk, as with conventional commercial loans, but can be higher according to Horizon Community Bank Senior Commercial Loan Officer Jeff Mizukami.
SBA loan types include general business loans, short-term microloans, real estate and equipment loans, and disaster relief loans.
There is a direct correlation between lender confidence and interest rates. Online loans have less paperwork, sure, but also a higher default rate. Therefore, you pay a higher interest rate for the online loan and often have less attractive terms, such as weekly or even daily payments automatically pulled from your bank account and a shorter payoff schedule.
Banks and the SBA have a more rigorous screening process, but that increased confidence is reflected in more attractive terms.
Term Loans – Based on a fixed or variable (floating) interest rate, a term loan is a short- or long-term arrangement to borrow a specific dollar amount with a fixed interest rate and repayment schedule, and is most commonly used for working capital, real estate or equipment funding. Term loans include fairly high qualification standards, but typically have longer payoff terms and lower interest rates than most other types of funding.
Term loans from a brick and mortar bank usually cost less over the life of the loan than a term loan from an online lender, but are more expensive than an SBA loan.
Short-term loans are typically less than five years, and long-term loans commonly range from five to fifteen years. According to Investopedia, loans with a term from one-to-three years are usually paid in monthly installments from a company’s cash flow and may have balloon payments tied to the useful life of the asset financed. A long-term loan runs for three to 25 years, is collateralized by a company’s assets and requires monthly or quarterly payments from profits or cash flow. The loan limits other financial commitments the company may take on, including other debts, dividends or principals’ salaries, and can require an amount of profit to be set aside for loan repayment.
Bankers often combine multiple types of loans into a single funding package, such as a short-term “bridge” loan to purchase land and fund construction, followed by a long-term mortgage loan at a lower interest rate.
Line of Credit Loans – More flexible in funding options, line of credit loans can be either secured with collateral or unsecured, and have a more flexible repayment schedule. Once you are approved and have a line of credit loan available, it’s up to the borrower if they choose to use the funds. Much like a credit card, payments are only required if funds are used from the open loan.
Business line of credit loans can have very attractive interest rates but, unlike a consumer line of credit, it’s typically not a fixed rate. It can flex based on the market at the time you borrow against the line of credit, with a major purchase leading to an unexpectedly high payment. The payment and length of payoff depends on the amount borrowed, which can be challenging for budgeting purposes but beneficial for unexpected financial needs.
Cash Advance Loans – Ranging from a merchant cash advance based on daily credit card sales to payroll shortfall loans and invoice financing (loans using accounts receivables as collateral asset), cash advance loans are somewhat similar to consumer cash advance loans such as borrowing cash from a credit card, a payday loan or an automotive title loan. Because they are so short-term that a lender is challenged with making revenue off the product, and because it often signals a business with low cash flow, cash advance loans are usually the most expensive form of business loan, and something to be avoided whenever possible.
Not only is it helpful to know different types of loans, but it’s important to realize that just because one lender might turn down a loan application does not mean ALL banks will turn it down. Not only do community banks approve more than twenty percent more applications than a large bank, but they’re also highly invested in their local community.
If you’ve been declined by a major bank, try Horizon Community Bank! We might be just what you’re looking for. (We also offer incredible interest-bearing checking accounts. #justsayin)