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Mar 30, 2020

Read Closely: How to Evaluate a Loan Offer

A business loan can put much-needed working capital in your pocket or help you to fund the next stage of growth for your operation. But before you sign on the dotted line, it’s essential to understand what you’re agreeing to. If you’re planning on applying for business financing any time soon, here are the most important things to know as you evaluate your loan offer. 

Review the Loan Amount

If you applied for a specific amount of funding, the first thing to check is whether you’ve been approved for the full amount. You may apply for $200,000 in funding but only get approved for $150,000. 

When there’s a gap between the loan amount that you’re approved for and the loan amount that you need, there are 2 options. The first is to accept the loan as is. The second is to turn down the offer and apply for funding with another lender to see if you can qualify for the full amount. 

If you accept the loan offer as is, make sure to do your due diligence and ensure you can get the job done with a smaller amount of capital (and without wreaking havoc on your business finances). Create detailed cost projections and financial projections to determine the minimum amount of money you actually need. Ideally, you have this number figured out before you apply for a business loan. 

Calculate the Total Loan Cost

The next thing to look at when reviewing a loan offer is how much borrowing will cost you. 

If you’re taking out a term loan, for example, the annual percentage rate may be the main number you zero in on. Annual percentage rate or APR reflects the annualized cost of the loan, which includes the interest rate and any other fees the lender charges. If you know your loan’s APR, you can use that to calculate the total amount you’ll repay between the principal, interest, and fees. 

For example, say you get approved for a term loan of $75,000 at an 8% interest rate. You have a 36-month loan repayment term. At that rate and factoring in a 3% loan origination fee, your total loan payback would come to $84,608.19. The cost to borrow would be $11,858.19, and your APR would be 10.08%.

Other types of financing may require a little more number-crunching to determine the cost. A merchant cash advance (MCA), for example, typically charges a factor fee rather than an interest rate. The total cost of the MCA depends on the factor rate, the holdback rate (percentage of your daily credit card sales taken as repayments), and how long it takes you to repay it. For example, let’s say you take out a $75,000 advance with a factor rate of 1.2 and a holdback rate of 20%. With an average of $40,000 in credit card sales per month, the total cost of the MCA would be $90,000, assuming you pay it off in a little over 8 months. The cost to borrow would be $15,000, and your APR would be 40.61%. 

It’s crucial to look at the total cost of your loan, including small business loan fees—and not just the interest rate or factor rate. You will get a better idea of whether the loan is something that makes sense for your business. 

Look at the Repayment Term and Payment Schedule 

Estimating the total cost of the loan is just one side of the affordability equation. The monthly payment is the other. 

If your loan offer doesn’t include an amortization schedule that breaks down your payments, be sure to ask the lender how much you’ll pay and how often those payments are due. Depending on the type of financing involved, repayment may be expected daily, weekly, bi-weekly, or monthly. 

Once you get a dollar amount for your repayments (you can use one of these handy calculators), look at your business’s typical monthly budget. Consider how the payment fits in with your cash flow and your ability to cover day-to-day operating expenses. 

Then, look at how long you’re going to be making that payment if you agree to the loan. If you’re getting an SBA loan or another type of long-term financing that has you making payments for 5 years or longer, you need to be sure your business can sustain those payments for the duration. 

Check Collateral, Personal Guarantee, and Lien Requirements 

Some business loans require collateral to secure the loan while other types of financing don’t. An equipment loan, for example, may use the equipment you’re purchasing as collateral while a business line of credit is often unsecured. Understanding what’s expected concerning collateral can ensure that there are no surprises once it’s time to finalize the loan. 

Keep in mind that if no collateral is required, you may still need a personal guarantee or a Uniform Commercial Code (UCC) lien. A personal guarantee means that you agree to be personally responsible for a debt your business takes on. If your business defaults on the loan, the lender could take collection actions against you to try to recover what’s owed.

A UCC lien is a blanket lien that allows a lender to attach any and all business assets in the event of loan default. Both a personal guarantee and a UCC lien could have severe implications if you default, so you want to make sure you know what the terms and conditions are. 

Due Diligence Pays Off

Taking the time to review your loan offer can pay off—seriously. By understanding your loan agreement, you will be able to sign on the dotted line with confidence. 

About the author

Samantha Novick
Samantha Novick
Samantha Novick is a content marketing writer covering business and finance for Funding Circle.


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