How to Decide if a Business Loan is Worth the Cost

Whether you’re struggling to keep cash flowing in your business or looking for a little capital to grow it, the idea of a business loan has probably crossed your mind. Business loans can provide you with a much-needed infusion of cash, but at what cost?

It’s important that you fully understand what a small business loan will cost you in the long run, to determine if it’s the best way to get financing.

Business loan for business growth

Can You Afford a Loan?

It may seem like a silly question since, don’t you take out a loan when you need cash? Yes and no. If you’re so strapped for cash you won’t be able to make the regular payments, you’ll jeopardize your business and risk your assets being seized.

A loan is never a good idea if you’re desperate or if your business is failing. It will be a temporary measure for a larger problem, and ultimately won’t solve it. Make sure if you do decide to take out a loan that you reserve part of it or otherwise budget to make your monthly or weekly payments.

What Do You Need it For?

This is a question that will require some soul searching. You may want the money for growth, or you may need it to cover payroll or other expenses. The answer to this question can help you determine if you should take out a loan or tough out a rough patch. It can also help you decide how much to borrow and what type of loan to take out.

If you need a quick cash infusion to cover expenses, a short-term working capital loan may be a good option, especially if you know you will be able to repay the loan quickly. Again, make sure you can repay the money or you’ll end up paying more than necessary with a short-term solution.

If you’re looking to lay down some serious cash to grow your business, you may prefer a traditional SBA loan, which you have years to pay back. This is best if you plan on buying equipment or have other expenses in the tens of thousands of dollars.

Either way, know exactly how you plan to use the money. Build a budget so that every cent is accounted for. This will keep you from feeling like you have extra cash you can use to take your team out for an extravagant dinner or to buy that $400 office chair you’ve been eyeing. The money you put into your business should have a return on investment, so planning helps here.

Make Sure You Assess the True Cost

You know that you pay interest on a business loan, but do you really have a sense of the costs over time? While interest rate is a factor, the APR, or Annual Percentage Rate, should also be taken into consideration.

The decision you need to make is whether you want to pay a high APR over a shorter period or a lower APR over a long period of time. Based on APR, alternative lenders are the most expensive option for your loan needs. However, even though SBA loans have a lower APR, over the 10 year period you can end up paying as much as triple what you would taking out a loan from an alternative lender that requires you to pay it back in months, not years.

Alternative business loans

Let’s look at two scenarios for borrowing $10,000.

  • With the SBA loan, you pay 4% APR and pay back the loan in 10 years, with monthly payments.
  • With the alternative online lender, you pay 75% APR and pay back the loan in 6 months, with weekly payments.

Unfortunately, if you’re a new business you won’t be eligible for SBA loans. SBA requires that you be in business for at least 2 years among other additional requirements. If your business is somewhat established and needs $10k to help finance an expansion – which won’t pay for itself immediately – the SBA loan is a great option. SBA loan will be more expensive in the long run, but its low APR will free up more capital early on.

Alternative lenders can be effective for a big opportunity that you can capitalize on fast, or to handle a temporary cash flow issue. For instance, if you needed $10k to purchase goods which you can quickly turn around a make a profit in a short period of time, then a loan from an alternative lender makes sense. However, using an alternative lender will require you to pay more up front. This will tie up capital and give you less breathing room.

The best option for your business depends on your needs and eligibility. As stated above, both options can be expensive, but in the short run, an SBA loan will be the least.

Other Options

Loans are by far not your only option for accessing cash. If you’re launching a new company or product, consider crowdfunding as a way to not only get money (that you don’t have to repay) but to also get your network excited about what you’re coming out with. If you have a credit card with zero interest or fees, that could be a good short-term solution to covering smaller business expenses. And if you’re comfortable with it, you can ask friends or family for a loan. Just make sure to treat it as a business transaction, sign an agreement on how you’ll pay it back, and pay interest on the money.

Borrowing money, through any channel, is a decision not to be taken lightly. Make sure you fully understand what it will cost you in the long run before making a move.