How does a business term loan work?
According to the experts at the Small Business Administration (SBA), the median small business loan is $140,000, and it’s uncommon for most loans to exceed $250,000. Business term loans provide a much wider span for entrepreneurs, starting around $5,000 and going all the way up to $2,000,000.
It’s important to note that term loans can fund within just a couple days, which is definitely on the shorter side. Not bad for a “basic vanilla” loan, right?
Many entrepreneurs use business term loans to expand their businesses, purchase equipment, hire staff, or acquire working capital. The best part of a business term is its versatility. Rather than following a strict rulebook on what you can and can’t use them for, plan on them being a valid option for just about any business need.
With a business term loan, the repayment terms usually fall between 1 and 5 years. The length of the term will depend on your credit, the lender’s requirements, and your preferences. As for the interest rate, they can start around 6%. This structure makes them one of the more borrower-friendly methods of financing available.
Because business term loans have either a fixed interest rate or flat fee, your payments won’t go up at any time during the loan’s lifetime. This certainty makes it easier to pay off because you’ll know ahead of time how it’ll fit within your budget.
How much will the loan cost?
Speaking of budgeting, it’s important to evaluate the cost before you ever sign on the dotted line. The first step in the process is figuring out how much money you need to borrow. The more specific you can be, the more you’ll be equipped to search strategically. The goal is to be as targeted as possible.
“Avoid guesstimating because you could end up with more debt than is necessary, or less money than you need,” says Experian. “Instead, take the time to calculate the loan amount based on detailed cost projections, and how much you can afford in monthly payments and interest. If you’re not sure how to do this, consider hiring an accountant who can help…”
You’ll also want to think about the timeline for the loan. If you have a pressing need for the money, business term loans can fund in as little as 24 hours. So you get the expediency of a short term loan, combined with bonus features like a much higher maximum for what you can borrow.
Remember, just because you can request up to $2,000,000 doesn’t mean you necessarily should. Be judicious in how much request.
“While there are numerous options from which to choose, not all deliver the same benefits,” advises Tom Coletta, a senior vice president at Axiom Bank. “Make a short list of potential lenders by shopping around to compare offers. As you go through the process, keep in mind that bigger isn’t always better—or safer.”
When you’ve identified a few loan options that match your borrowing and repayment timeline, it’s time to evaluate them to find which is the best match for your unique business needs.
Here are 4 metrics you can use to get a better idea about a business term loan’s pricing:
- Total Cost of Capital (TCC): When you add up the loan’s interest, fees that don’t charge interest, and ancillary fees, you’ll get a dollar amount that helps you understand the totality of the cost.
- Annual Percentage Rate (APR): To get insight into the cost of your loan, this handy metric puts it into a yearly perspective.
- Average Monthly Payment: Your business has lots of monthly expenses, so it’s helpful to view your loan on a similar scale. This metric helps to see how much you can afford to borrow.
- Cents on the Dollar: To get an amount that’s boiled down to the purest essence, this metric helps you see how much money you’ll need to spend in fees and interest for every dollar borrowed.
During this evaluation time, be on the lookout for hidden fees. Some lenders will try to wedge in extras like processing fees and early repayment fees without clearly disclosing them.
Another factor to consider in the cost of a business term loan is collateral. Whether that collateral is your home, a piece of real estate, or your beloved Harley-Davidson Blue Edition, this element of the loan could have an impact on you.
“Term loans are most appropriate for established small businesses that can leverage sound financial statements and substantial down payments to minimize monthly payments and total loan costs,” says Forbes. “Repayment is typically linked in some way to the item financed. Term loans require collateral and a relatively rigorous approval process but can help reduce risk by minimizing costs. Before deciding to finance equipment, borrowers should be sure they can make full use of ownership-related benefits, such as depreciation, and should compare the cost with that leasing.”
Evaluating your options
It can be difficult to compare loans because lenders handle their disclosures differently. For example, the APR on one loan could be listed in a different way than another.
So how do you make an educated decision on a loan when the educational materials are inconsistent? The Innovative Lending Platform Association (ILPA) teamed up with multiple lending platforms to provide a solution: a comparison tool named SMART Box™ (Straightforward Metrics Around Rate and Total cost). It helps you line up pricing metrics and calculations get a realistic view of which loans are true contenders.
“Access to capital is a top priority for NSBA (National Small Business Association) and we appreciate how SMART Box allows small businesses to more fully assess and compare lending options,” explains Todd McCracken, president and CEO of the NSBA. “This type of price transparency, along with best practices like the ones adopted by the Coalition for Responsible Business Finance (CRBF), will help solidify the trust between non-bank lenders and small businesses.”
There is a version of SMART Box™ tailored specifically to term loans. There are also separate versions designed for merchant cash advances and lines of credit.
Just remember, tools like SMART Box™ are meant to complement your efforts. They aren’t oracles and they can never replace the value of good, old-fashioned due diligence.
Applying for a business term loan
Once you’ve weighed your options and chosen the best financing product, it’s time to prepare for your application. Resist the urge to take this action too quickly. You need to make sure you fulfill all the lender’s requirements perfectly. As the old saying goes, “Close only counts in horseshoes and hand grenades.” And in an application, close certainly won’t cut it.
You’ll need to set aside some time to gather the proper documents. Different lenders have different requirements, but here are some common documents requested from potential borrowers:
- Background information such as education history, previous addresses, criminal record, and other names you’ve used
- An airtight business plan including proof of cash flow, profit and loss, and balance sheets
- Credit reports
- Personal and business tax returns for the previous 3 years
- Financial projections
- Personal and business bank statements from the previous year
- Information on personal or business property you could use as collateral if necessary
- Business licenses and registrations
- Any articles of incorporation
- Franchise agreements
- Commercial leases
What happens after you click submit
Once a lender receives your application, their job is to determine whether or not you’re a safe bet to repay the money they might lend you. This evaluation isn’t unusual—you’d probably do something similar if a friend asked to borrow money. It’s not that you’re stingy, but you need to make sure you can trust someone before you loosen the purse strings.
You can expect lenders to pay particular attention to both your personal and business credit. At their essence, your credit scores serve as algorithms that predict whether or not you’ll repay the money you borrow.
Your personal credit score is determined by financial data such as how promptly you pay your bills and how much of your available credit you’re utilizing. On the business side, lenders will look at a broader set of factors to help inform their decision. Here are a few of the most important:
- Business credit
- Business experience
- Value of collateral
- Access to capital
- Business plan
- Financial projections
Even if you present a solid case to the lender, prepare for the occasional rejection. The majority of loan requests to banks are turned down, which says more about the competitiveness of the industry than it does about you personally.
The best route is to remain proactive throughout the process. That way, you’re ready to roll once you get approved. You can also apply through a marketplace like Lendio, because marketplaces tend to do a better job at finding loan approvals for small business owners.
“Keep in contact with the lender throughout the process to make sure it’s going smoothly,” recommends Experian. “As soon as the loan closes, create a strategy to pay off the loan. A good strategy can help you avoid the problems that come with defaulting, including losing your collateral and seeing a negative impact to your business or even personal credit score.”
If you find yourself being turned down for multiple loans, it probably means you need to tighten some elements of your finances before you get a green light from a lender. The first place to look is your credit because a higher score will almost always improve your approval chances. Second, it’ll help you secure more favorable terms and rates on a loan (potentially saving you thousands of dollars).
If your score isn’t where you’d like it to be, start taking the steps necessary to fix it. Do you even know your current credit scores? If yes, congratulations on effectively monitoring your credit. If not, get in gear and check with the 3 major credit bureaus. Data shows that 1 in 5 Americans has errors in their reports. If you’re one of those unfortunate people, the only way you’ll get that fixed and see a corresponding boost to your score is to take care of it yourself.
Another way to shore up your credit is by signing up for automatic payments on credit cards and other obligations. You’re a busy person and mistakes can happen, so instead of risking the occasional late payment, let technology handle them for you. Some payees might not have a system that lets you schedule automatic payments, but you can always just do it on your end through your bank’s app.
By safeguarding your credit and making yourself a better candidate for a business term loan, you’ll make life easier for lenders. It’s incredibly difficult for them to examine every application, and they take no pleasure in issuing rejections. So each step you make in improving your finances gets you that much closer to your desired loan.