How do Business Loans Work?
Published on 2021-09-22
Category: Business Strategy, Business Growth
Are you an entrepreneur looking to power up your business but facing a cash crunch? Whether you are looking to increase inventory, purchase real estate, cover daily expenses, hire more employees, renovate, invest in equipment, or give a marketing push to scale your business, you might be feeling you could do great with some extra funds. A Wells Fargo Small Business Index poll revealed that a small business requires about $10,000 as start-up capital on average. Before approaching a creditor, you need to consider how business loans work for you.
Types of Small Business Loan and Repayment Terms
As a business owner, you have several choices when applying for small business loans. Any of the following business loans could be right depending on the reason you are looking for the loan:
- Secured Loans: You can get a secured loan by pledging a property or other tangible assets like a vehicle as security or collateral. It is extended based on the fixed instalment mode within which the applicant needs to pay back. The loan is approved with collateral attached; it attracts a lower interest rate and is available for a longer repayment tenure. The documentation makes the loan application a longer time to process. The loan is an excellent choice when looking for a more significant loan amount. However, there is a risk to property in case of default.
- Unsecured Loans: This is a short-term loan popular among small business owners. The loan is available without pledging any asset or security against the debt. The business owner needs to show a good credit rating, good cash flow potential, and a solid financial record for getting the loan quickly approved. The loans are available for a shorter repayment term ranging from 3 months to 3 years. The loan amount is available from AUD 5000 to AUD 500K based on business turnover. The interest rates are often higher.
- Business Line of Credit: It involves having access to credit when you need it instead of searching for ways to use a lump sum loan. The revolving business loan has a repayment period that covers two phases where you first get to draw the credit, use it, repay it, and use it again. Then the next phase is when the repayment begins, and you cannot access credit but only repay it. Creditors require you to have solid financials and few years in business to ratify this loan.
- Equipment Financing: It is available to finance an asset, or an equipment purchase for the business. The instalment-based loan requires the asset to be put up as collateral, thus making it an easy option for the new business owner. Due to the collateral, the interest rates are lower, but the commitment tenure is long.
- Invoice Financing: The cash flow-based loan involves availing a loan on the accounts receivable put up as collateral. You can repay the debt when you receive the payment for the invoice. Though new business owners can get the loan approval easily, they can expect a higher interest rate. It is different from invoice factoring, where the invoice is sold to a third party for cash rather than borrowing against it. The invoice gets you less money than the value amount of the invoice. You need to have a strong business track record for this loan approval.
Check Your Eligibility to Assess If the Business Loan Works for You
Irrespective of which business loan you apply for, you need to fulfil some eligibility requirements to qualify:
- Credit Reports: A good credit score indicates good financial health,but the creditors also check the credit reports. The absence of glaring issues like a payment default, a foreclosure, a bankruptcy, or an account in collections shows responsible credit use. A good credit report will help even if you have a less than stellar credit score.
- Years in Business: Lenders hesitate in giving loans to new businesses due to the risks involved. But some business loans are easy to get. Merchant cash advances, loans with collateral, trade credit, equipment financing are easy to get even if the venture is new.
- Personal and Business Credit Score: if your business has a credit history, creditors will check to see your credit management ability. If your company does not have a credit history, they will review your personal account credit score. This is primarily because most lenders require a personalguarantee that youwillrepay with personalassets even if the business defaults.
- Business Finances: Most creditors seek information about the cash flow statements, balance sheets, profit and loss statements, and future projections. The stronger your financial position, the more likely is your loan to be approved.
- Collateral: Though all businesses do not require collateral, having one can help you get a loan approved faster than unsecured business loans and at alower interest rate.
Alternatives to a New Loan When You Need Funds
Loan Top-Ups:You can get a top-up on the existing loan from your current lender. The top-up loan can be used to repay the old loan and then pay out the balance. The time and amount for top-up will determine the monthly instalments that you now need to make. For example, if the current pay out amount is AUD 6000, and the top-up amount is AUD 10000, you can get AUD 4000 as the top-up amount.
Consolidate Loans: If you have several loans running and find it challenging to keep track of different interest rates, repayment terms, and dates, loan consolidation can be an excellent option to reduce stress. You need to work out the amount of outstanding debt left on your existing loans and apply for a consolidated loan to cover the amount. The loan consolidation can help to simplify the finances, reduce the monthly payments, and help you get back on your feet. You need to assess your current finances, weigh all the choices available and decide what would help your business best.
Approaching an informed business loan broker can be a step in the right direction. Loan brokers can help you to secure loans with lower interest rates and better terms. Independent consultants assist in the assessment, develop a plan, and offer impartial advice with their knowledge and in-depth knowledge about the processes and options.
Whether you are just launching a new business or expanding an existing one, you need to tap into resources other than your own. The options above can help you narrow down the right financial solution for your unique requirement.
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