Did you know that eight out of 10 businesses eventually will fail? One of the top reasons why businesses fail is a failure to achieve profitability.
If you’re finding that your small business is on the brink of failure, your revenue stream is slow, and you can’t pay your expenses, a business loan might be the jolt of energy your business needs.
Navigating the world of business loans can be confusing, though, as there are many different types of business loans out there. This guide will give you the basics of each of these loans and get you on track to finding the right loan for you and your business.
Read on to learn more.
Line of Credit Loans
Taking out a business line of credit is very similar to a home equity line of credit. Basically, you get approved for a certain amount of credit and you can draw on it whenever you need it. Rather than getting it all in one lump sum, you withdraw money as you need it.
As you repay what you’ve borrowed, you can borrow more, up to your maximum, and pay interest on only the money you have borrowed (not the entire maximum line of credit amount).
The annual percentage rates vary and the repayment terms are usually short (think six to 12 months), but they can be a quick way to get back on solid financial ground. The specific terms of your loan will depend on your revenue and credit score.
A loan from the Small Business Association (SBA) is backed by the federal government, which means that the interest rates are generally lower since lenders are confident they’ll get their money, even if you default.
SBA loans range from as little as $5,000 to over $1 million. There are different types of SBA loans, such as microloans used to fund new businesses that don’t need more than $50,000, disaster loans, used to rebuild after a natural disaster, and CDC/504 loans to purchase commercial real estate.
While the rates are low and the repayment terms are typically favorable, the long and cumbersome application process is a definite downside to SBA loans.
Conventional loans, like conventional mortgages, generally have the lowest interest rates. They are hard to get, however, and only about a quarter of conventional business loan applications are approved.
The approval process is generally quick for conventional loans, but they often have repayment terms that are less than favorable when compared to SBA loans. The repayment term is typically shorter and they often include balloon payments.
Merchant Cash Advance
A merchant cash advance alows you to borrow a lump sum of money in exchange for a percentage of your credit card transactions. The APR can vary from as low as 15 percent to as high as triple digits. You keep paying the loan until the full amount is paid off, which could be as few as three to four months or as much as 18 months.
A merchant cash advance is a good option for your business if you have poor credit and may not qualify for more traditional loans.
Invoice Factoring Loans
Invoice factoring, or financing, allows you to sell your unpaid invoices to a lender. The lender gives you an advance of between 60 and 90 percent of your unpaid invoices. The lender then collects the unpaid amounts and sends you the rest of the money, minus any fees that they collect.
Qualifying for these loans is relatively easy, since you are using the collateral of your unpoid invoices. Your credit rating and the history of your business isn’t that important, since this loan is backed by collateral.
Balloon loans give you the full balance of the loan when the terms are agreed upon and the loan is funded. You only pay interest during the life of the loan and then at the end, a full payment (the “balloon”) is due to repay the entire principal amount of the loan.
These types of loans are often used if a business is waiting on a payment from a client for goods or services and they know when that payment will be coming.
Secured vs. Unsecured Loans
The difference between secured vs unsecured loans is the presence of collateral. An unsecured loan does not require you to put up any collateral. Collateral is something that you promise the lender in case you don’t pay the loan, such as your unpaid invoices, real estate, or product inventory.
Unsecured loans are generally only available to businsses with high credit ratings, a strong history of profitability, and those who are deemed low risk by lenders.
On the other hand, a secured loan requires collateral. Typically, if you are a more risky borrower, want the loan for longer than 12 months, or are making a large equipment purchase, your lender may require a secured loan.
If you default on the loan, the lender can collect your collateral as payment. The interest rate is typically lower for a secured loan and the repayment terms vary.
Of the Different Types of Business Loans, Which is Right For You?
There are many different types of business loans, depending on what your needs are, what your business history is, and how risky of a borrower you are. The less risky you are, the more favorable your loan terms and interest rate will be. Good credit isn’t just important for individuals, but for businesses too.
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