Guide To Business Loans

1. What is a Business Loan?

Next Read: How Do Small Business Loans Work?

Business Loans

What is a Business Loan?

Sep 06, 2022 • 8 min read
Table of Contents

      You’ve started your own business and are looking for financing options. Congrats! The world of business loans can be confusing to first-time borrowers, so read on to learn more about what a business loan is and how they work.

      What is a business loan?

      A business loan is a financing agreement between a business and a lender. Similar to a personal loan, a business loan will provide the business with a designated amount of money to be repaid over a certain period of time.

      Common reasons to get a business loan include:

      • Cover everyday expenses
      • Purchase property
      • Purchase business equipment
      • Launch a new product or service

      There are many different types of financing options for your business, so it’s smart to understand how each one works and which is best for your needs.

      How business loans work.

      When you take out a small business loan of any kind, you borrow money and pay it back over time, along with interest and fees. You may receive a lump sum of cash to use as working capital or to purchase equipment or inventory, or you may gain access to credit to make purchases as needed. 

      Business loans can be unsecured or secured. An unsecured business loan means you do not need to pledge any assets to use as collateral, although you may be required to sign a personal guarantee. With a secured loan, you do have to pledge assets that are equal in value to the loan amount. Common examples of business collateral include inventory, real estate, and equipment.

      Types of business loans.

      There are several different types of business loans that may suit your business. It’s highly recommended that you explore some of the most common financing structures to see which ones could be an option, including the following. 

      Short-term loan

      If you’re looking for first time small business loans that get you funding fast, consider a short-term loan. The repayment term typically lasts up to 3 years. As a result, funding amounts are usually lower than longer term loans—typically you can expect to borrow up to $500,000.

      Short-term loans usually come with a quick and easy online application process. In addition, they usually come with a fixed interest rate with predictable weekly or monthly payments. Time to receive funding is also usually short, so if you need quick access to capital for your business, a short-term loan is definitely something to consider. 

      Business line of credit

      Instead of a lump sum of cash, a business line of credit gives you access to a credit line that you draw from at your own pace. You only pay interest on your outstanding balance, and your available credit replenishes as you make payments. This could be a good option for financing inventory purchases, ensuring smooth payroll, or getting your business through seasonal slow periods. 

      There’s usually a time limit for how long you have access to your line of credit, but many lenders allow you to renew the term if your account is in good standing. 

      SBA loan

      There are several types of SBA loans, which are made through regular lenders, but backed by the U.S. Small Business Administration. You can borrow larger amounts and enjoy longer repayment terms. The downside is that the application process can be cumbersome and take a long time. So SBA loans are better suited for non-emergency financing needs.

      SBA 7(a) loans are the most common SBA loan type, because the funds can be used for general purposes. SBA 504 loans are for larger businesses seeking money for a specific project. An SBA Express loan is for smaller amounts, but comes with an expedited application review period of just 36 hours.

      Business cash advance

      A business cash advance allows you to borrow money based on expected revenue. Your business typically must experience daily purchases, and the advance is repaid by taking a percentage of those sales each day. A fee is added to your loan balance, and you’re typically given a repayment term of up to 2 years.

      It can be an expensive type of financing and eat into your profit margins and cash flow. As you’re considering this option, be sure to realistically gauge how confident you are in your business’ ability to generate regular sales. 

      Equipment financing

      Equipment financing is used to pay for any kind of business equipment you need for your company. It could be used for anything from restaurant equipment to a company car or even office furniture. Equipment financing is an attractive option to many business owners because the purchased equipment is usually used as collateral for the loan. Once you pay off the balance, you own the equipment in full.

      Loan amounts are high with equipment financing, with the upper limit at $5 million. Interest rates can also be lower compared to other business loan options, since the equipment loan has collateral to go with it. 

      Common features of a business loan.

      When comparing different types of business loans, keep an eye out for each of these features:

      • Loan amount: Different lenders may offer you a different loan amount.
      • Interest rate: Check the interest rate on every loan offer, so you know exactly how much your financing will cost. 
      • Lender fees: In addition to interest, some lenders may also charge origination fees, prepayment penalties, and more. Read the fine print of each offer so you don’t end up owing more than you expected.
      • Repayment term: Repayment terms can last anywhere from a few months to several years. A loan with a lower interest rate could still end up costing more in the long run if there is a long repayment term. 
      • Payment frequency: Are payments due daily, weekly, or monthly? A less frequent payment schedule is usually better.

      How to apply for a business loan.

      How hard is it to get a business loan? Lenders typically look at three primary factors when determining eligibility. 

      Credit score: Even though you’re applying for a business loan, lenders still check the personal credit score of the owner. Anything above a 720 is considered good, but you may still qualify with a score in the 600s. You may just need to offer collateral in order to get approved.

      Time in business: Each lender has its own requirements for the amount of time you’ve been in business. Traditional banks and SBA lenders usually require a minimum of two years. But some online lenders may approve businesses that have been around for three to six months.

      Business revenue: Revenue requirements vary depending on the lender and how much money you want to borrow. You may see monthly or annual revenue requirements so check with lenders in advance to see if you qualify before starting an application.

      Final thoughts

      Understanding the types of business loans is crucial to growing and scaling your company. Ready to jumpstart the next chapter of your business?

      Apply for a small business loan.

      Quickly compare loan offers from multiple lenders.

      Applying is free and won’t impact your credit.

      About the author
      Lauren Ward

      Lauren Ward is a personal finance and tech writer with a passion to help consumers make smart financial decisions. Her work has appeared in a variety of publications, including Time and MSN. When she's not writing, she loves gardening and playing board games with her family.

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