When your business is in need of funding, finding the right business loan can be overwhelming. Sorting through the types of business loans is often confusing and time-consuming. You can make choosing a business loan easier by understanding the important factors that go into finding a loan that’s a good fit for your business.
This guide will help you choose between the types of small business loans by outlining the options available, important factors for a business owner to consider and how to find the best lender for your needs.
Who Needs a Business Loan?
Even the most successful businesses often need to have financing options available. Running a business can be expensive, especially if you have a slow month or an unexpected cost arises. You might consider securing business financing for a number of reasons, including:
- Unexpected Expenses: Whether your office printer suddenly quits, your delivery vehicle needs new tires or you have an unexpectedly high tax bill, there are types of small business loans that can help you pay for these sudden costs.
- Seasonal Business Volume: Some businesses, such as a landscaping company, have seasonal busy periods. During the slow times, a loan can help your business afford to pay regular expenses until the next busy season.
- Outstanding Invoices: Customers don’t always pay on time, but a business loan can help you cover expenses until unpaid invoices are paid.
- Employee Costs: Whether you’re dealing with high turnover or need to hire more employees for a busy season, loans can help cover the cost of recruiting and training new hires.
- Expansion and Growth: Business is booming, but you need money now to take advantage of new growth opportunities, such as opening a new location in a desirable neighborhood.
Types of Business Loans
In order to find a loan for your business, you’ll need to know about the different loan and financing options available. There are a large variety of loans, credit lines and other funding solutions, each with their own advantages and drawbacks. Learn more about the different financing options that might be available for you.
Long-Term and Short-Term Financing Options
You can generally think of business financing in two categories: long-term and short-term. Long-term financing options are often repaid over several years. Depending on the amount you need, a long-term loan could take decades to repay. Most business loans from traditional lenders, like banks or credit unions, are long-term.
Short-term financing, on the other hand, is used for immediate business needs and is usually repaid within a year. This short loan period helps your business avoid being tied up in a loan for years, which can help keep cash resources available for other needs. Some advantages to choosing a short-term loan include:
- Shorter repayment period
- Lower total interest costs
- Fewer fees
- Easier application
- Higher approval rates
- Quick approvals and loan funding
Types of Small Business Loans
Getting the right financing solution for your business can help you save money on the cost of your loan and meet the specific needs of your business. There are many different types of business loans. Depending on your lender, you may even be able to customize your business financing to fit your business’ exact needs.
Long-Term Business Loan
Long-term loans work in the same way as a personal installment loan, such as a mortgage home loan. Due to the long repayment period, long-term business loans are best suited for business owners looking to make a major change to their business. Building a new office building, investing in commercial real estate space or undergoing a major renovation are some reasons you might choose a long-term loan.
The high cost of these projects makes long-term loan payments easier to handle, as the length of the loan can help lower the monthly payment cost. With this loan option, you’ll get a lump sum of money to pay for your project and make scheduled payments with interest for the life of the loan.
Short-Term Business Loan
A short-term business loan is ideal if your business needs a quick influx of cash to cover expenses right now. You might be waiting on customer payments or the busy season, and a short-term loan can help you get the money you need. Out of the different types of business loans, a short-term loan is one of the most common. It allows you to pay for things even if you don’t currently have enough cash on hand, or you don’t want to completely empty your cash reserves to cover an expense.
A short-term business loan gives you a lump sum of cash immediately. You’ll then repay the loan in scheduled payments, usually either daily or monthly, until the loan is repaid.
Financing business equipment, including equipment leasing, provides funds to help you pay for the expensive equipment necessary to run your business. Depending on your business and industry, leasing new or pre-owned business equipment may be right for you. Through equipment leasing, you’re able to get the updated equipment your business needs without the cost of buying outright. You may even be able to save money on taxes by using the Section 179 Deduction.
Business Line of Credit
Much like a personal line of credit, a business line of credit gives you access to revolving credit that can be used as needed. Lines of credit work similar to a credit card, but instead of swiping a card, you’ll have access to cash. If approved for a line of credit, you’ll be given a credit limit. You can borrow the cash you need up to your credit limit. A line of credit can help build your business credit score, but they are often difficult to obtain and require lengthy applications and approval periods.
Merchant Cash Advance
Merchant cash advances are a type of business loan that can be repaid using future credit card sales. After receiving your loan, your point-of-sale system will be set up so that a percentage of each credit card transaction is sent to your loan balance. While merchant cash advances can be easier to obtain than other types of business loans, they are often costly. You won’t have a set repayment schedule with a merchant cash advance, as the loan is repaid based on credit card sales volume. Additionally, if your business doesn’t do a lot of credit card sales, it will be difficult to repay your loan.
Businesses with late customer payments may like the idea of invoice factoring, although it is a less common loan type. Invoice factoring works by an invoice factoring company buying your unpaid invoices from you. Usually, customer payments are made directly to the factoring company. The company then pays you the money from your invoice and takes a cut as their fee. This financing method can help cover immediate needs, but the fees taken out of your invoices can be high, and factors like how long a client takes to pay can increase the cost.
Business credit cards can help you access funds and build business credit. They give you a payment method that’s easy to use without having to carry cash. The drawbacks of credit cards, however, are the high interest rates and credit limits that may be too low for your spending needs. If you need cash to cover expenses or free you up for a growth opportunity, a credit card probably isn’t the best business financing option. Credit cards usually charge large fees for cash advances, causing you to spend more to access cash.
What to Consider when Choosing Between Types of Business Loans
No matter what type of loan you’re considering for your business, you’ll want to take a closer look at both the fine print and the needs for your industry and type of business. Assessing these important factors will help you make a smart choice when financing your business.
Before you can choose a business loan, it’s best to figure out how much money you’ll need and how you’ll use the funds. For example, if you’re opening a new location, you’ll probably want to contact contractors and other professionals to get an estimate on how much your project will cost so you know what size loan you’ll need. Additionally, if you’re choosing between a few different loan types, defining how you’ll use your funds can help you find the right financing solution.
Most business owners know they need to look at the interest rate of a loan, but it’s always smart to have a reminder. Read the details of your loan to find out how interest is calculated. Most of the time interest is shown as an annual rate. However, you should look at more than just the annual percentage rate for your loan. Consider the total cost of interest over the course of the loan. A shorter loan may come with a higher annual interest rate, but you may actually save money on the total amount of interest paid because you’re paying for a shorter period of time.
Length of Term
In addition to having a long-term or short-term loan, the actual number of months in your loan terms is important to finding the right loan. Different types of small business loans offer different loan terms, so you’ll want to choose one that fits your business model. Businesses with a slow period, for example, might want to have their loan paid off before the slow season hits so they can free up the funds that were going toward loan payments.
By choosing a shorter loan term, you can have your loan paid off sooner and keep your incoming cash for other business needs. On the other hand, you might have steady business all year long and want to lower your loan payment by lengthening the term to a full year. This reduces your daily or monthly expenses and frees up cash flow.
Many loans, including long-term loans, require a lengthy application process. The long application is usually followed by a slow approval decision and distribution of funds. Even if you’re approved, this process could take weeks, and if you’re not approved, you’re back to square one. When your business needs cash to cover immediate needs, this process simply won’t work.
Many short-term loans and solutions like credit cards have quick applications that take a few minutes to complete. Most of the time these loan types also don’t require extensive business financial records or a business plan. Additionally, most short-term loans can be funded quickly so you’ll have your money when you need it.
Having the option to set up a loan payment method and schedule that works for your regular cash flow can be vital to your business success. Some lenders allow you to set up flexible payments or choose your scheduled due date. Flexible payment options may include deferred payments so you can plan for skipping payments during your slow season. This makes it much easier to plan for your loan payments so you know you’ll have the money ready to make a payment.
Credit History and Approval Rates
Having a good credit score can make securing most types of business loans easier. If you have good credit, you’re more likely to qualify for the best loan terms, including potentially lower interest rates. However, not everyone has perfect credit. If your credit is less than stellar, you can increase your chance of being approved for a loan by looking at loan requirements and approval rates.
Some lenders, especially alternative lenders that offer short-term loans, provide business loans for bad credit so you can still get the money you need to grow and run your business. These lenders generally offer higher approval rates than traditional lenders like banks, credit unions or a Small Business Administration loan.
Budgeting for a Business Loan
You can make repaying your business loan much easier by taking some simple steps before applying and during the loan repayment period. Learning to budget for your loan payments can help you stay on top of payments and maintain your cash flow as you pay off your loan.
- Have a Payment Ready: Set aside emergency savings equal to the amount of at least one loan payment. From a new unexpected business expense to sales falling below your projections, you never know when you might need the extra cash to cover your loan payment.
- Plan Payments Ahead of Time: Once you know what your payment will be, start putting together a plan for how you’ll meet this daily or monthly payment. You’ll feel less stressed if you have a clear plan in place to make payments and can see in advance how they’ll affect your finances.
- Pick the Best Due Date for Your Business: If your lender lets you pick your due date, make sure you pick a day that works best for your business. Look at your normal cash flow and schedule your payment for the time when you usually have the most cash reserves available. This can help you avoid scrambling for the money to make a loan payment.
- Check Prepayment Fees or Discounts: Some lenders charge an extra fee is you pay off your loan early. On the other hand, some lenders are happy to let you repay your loan early, and may even offer an early payoff discount.
- Payment Options: Ask your lender how you can pay for your loan. Some lenders require you to send in a check each month for payment. Others will set up an automatic withdrawal from your business bank account and may offer a discount for automatic payments.
How to Choose a Lender
The lender you choose for your loan is as important as understanding the types of business loans available. Getting the right lender can help you feel confident that you have the support you need to successfully run your business.
Traditional Lender vs. Alternative Lender
Lenders may be broken down into two types: traditional lenders and alternative lenders. Traditional lenders include financial institutions like banks or credit unions. Traditional lenders often have longer application processes and strict requirements for funding. These strict requirements make it more difficult for business owners with poor credit or other factors to get approved for a loan. The approval and funding process can take weeks.
Alternative lenders, on the other hand, provide a simpler approach to business funding. Most online lenders provide a quick application process. Using financial technology, alternative lenders are able to speed up the loan decision and funding process. They also usually offer a range of loan options for people with bad credit, making their approval rates much higher than many traditional lenders.
Finding the Lender that’s Right for Your Business
Once you know what you need out of a business loan, you can find a lender who matches those needs. Most of the time, an alternative lender is a good choice for business owners who need a loan solution that is funded fast. Be sure to speak with lenders and ask important questions about their loan products. Often the best loan for your business comes from a lender who can create a customized solution that’s tailored to your business’ needs, cash flow and repayment timeline.
Understanding the types of small business loans available to support your business goals may seem complicated, but it doesn’t have to be. Now that you know the types of loans, what to look for when considering your options, and how to choose a lender, you can get started on taking your small business to the next level.