Well that’s because banks tend to have a few more scruples than higher-risk lenders, and will offer more favorable terms, specifically regarding the interest rate you’ll have to pay on the loan amount.
Using the bank to help you pay off sudden emergency needs, or eliminate higher-interest debt, can save you hundreds or thousands in interest payments. A small business loan, including lines of credit, are also less expensive than credit cards, which generally have much higher interest rates.
Here are the 3 most common bank loans available to small business owners (consolidation loans not included):
1. Term loans
Very simple definition for this one. Term loans require that you pay the balance back within a set time limit, plus interest for the lender’s trouble. The longer the payment term offered, the less interest is generally paid, and the more collateral required. Short (intermediate) term loans come with higher interest rates and are generally given to businesses who’re dealing with a sudden financial crisis.
Approvals are based on a mixture of credit history, current revenues, and the amount of collateral available to sign over to the lender in the event of a default. Fees a business pays for the privilege of this kind of loan include: Annual Percentage Rate on loan (APR), origination fees, closing fees, and documentation fees. These charges are normally factored in and paid in equal installments alongside agreed upon monthly or quarterly loan payments.
2. Small Business Administration (SBA) loans
SBA loans work in the same way term loans do, though are partially guaranteed by the US government. This is an effort by the government to help small businesses prosper and grow. The terms are generally longer when approved, and interest rates are also far lower than that offered by banks and private lenders.
Approvals aren’t easy to secure, as there are a limited number of loans to give out and thousands of businesses vying for them. Those who’ve secured an SBA loan can tell you that the paperwork requirements can be very time-consuming.
3. Business Line of Credit
A BLoC is nothing more than a glorified low-interest credit card. Once approved for a set amount, a business can draw from their line of credit whenever they need it, then pay off the balance as it suits them. Interest is charged and minimum monthly payments are required if the balance can’t be cleared right away.
Approval for a line of credit will depend on the same factors as a term or SBA loan, but are generally easy to secure when the business has a good credit history and the financials to prove they can keep up with the balance. Larger lines of credit generally require collateral too, but not every time. A BLoC is a smart way to secure a security fund when you’re not in financial need, as you can chip away at smaller financial woes as they occur and prevent them from becoming bigger problems.
What you’ll need to be granted a bank loan
Also called a “Profit and loss statement” by certain lenders. An income statement is simple in principle. It details your net income, along with revenues minus expenses (including payments on other debts) for a set period, such as quarterly or yearly. The income statement is the first step to being considered for a loan, as it tells lenders what the financial health of the business is – Ie., how likely you are to repay.
Collateral to back the loan
Collateral may be required if you don’t have a credit history, have poor credit, or your ability to pay off the loan on time is questionable. Collateral can include the business’s property, equipment, outstanding receivables, inventory and anything else that can be liquidated quickly to recoup the money if you can’t pay.
You should immediately be in contact with a lawyer if the bank requires a personal guarantee on the loan or line of credit you take out. Basically, in lieu of a healthy income statement and good collateral, some banks will ask for a personal guarantee if you own property or have savings (such as a retirement savings fund) that can pay off the debt if you default. This is a scary step that only the most confident of business owners should consider. Defaulting on a business loan can spell business bankruptcy – this option if exercised, can lead to personal financial ruin too!
Always consult an accountant and lawyer whenever you consider getting into an agreement with any bank. Terms can be hard to read, and will vary based on specific lenders and current market conditions.
Never let desperation lead you to making reckless decisions, as the money issues you’re facing currently (such as launch, growth, or emergency expenses) can be magnified ten-fold if you get suckered into a bad loan arrangement.