How Do Small Business Loans Work? – Bankrate.com

How Do Small Business Loans Work? – Bankrate.com

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If you’re considering launching a small business or the time has come to expand operations, a small business loan may be able to provide the money needed to achieve your goals.
There are many different types of small business loans, and the requirements to qualify for each, such as the available loan amounts to be borrowed and the repayment terms, vary. Learn more about the loan process and decide on the financing option that best suits your needs.
Business loans are funding that can be used to help start or grow a business. These loans can be used to fund large, one-time expenses or expansion. They can also cover the costs of operating your business, including paying for salaries, office supplies and inventory.
How you plan to use your business loan impacts the type of small business loan you choose. For some business owners, the funds may be used to cover day-to-day operations, while others are interested in purchasing equipment or vehicles.
The below common types of business loans have varying loan amounts, interest rates, fees, eligibility criteria, possible uses and repayment terms.
 
Businesses considering a small business loan can choose between secured and unsecured business loans, which are repaid over a set period, including interest and fees.
A secured loan requires you to put down collateral, while an unsecured loan does not. Loan collateral might be the equipment, real estate or other asset you acquired with the loan funds, but it can also be money. If the borrower fails to repay or defaults on the loan, the lender can take possession of the collateral to cover the borrowed amount.
While unsecured loans don’t require collateral, they often require a personal guarantee, meaning you and other business owners pledge responsibility for repaying the debt.
Here’s a closer look at how a few popular types of business loans work.
Term loans provide a lump sum of cash that is paid back over a set period of time, typically between two to five years. For applicants with good credit scores, these loans often come with competitive interest rates.
The application and funding timeline for term loans may also be relatively quick, depending on the lender. Online lenders can often approve and possibly fund in less than a day. But if you have less than ideal credit, a lender may require that you provide a personal guarantee to obtain funding. This means you agree to repay the loan with your own money if, for some reason, your business cannot meet the loan obligations.
There are various types of term loans, including options designed for equipment financing and to provide working capital.
SBA loans can provide operating capital or be used to cover other business expenses, including expansion and large purchases. These loans, partially guaranteed by the U.S. Small Business Administration, are known for having low rates and long repayment periods, making them a particularly affordable borrowing option. But they also take the most time to apply for and have strict qualification requirements. Often, these loans require a good credit score and solid business revenue.
SBA loans have strict qualification requirements and a slower funding timeline while often requiring a good credit score and solid business revenue. That said, there are options available for those with bad credit or newer businesses.
The SBA’s weekly lending report shows that over $5 billion of approved funds have gone to startups that will use the funding to open their doors. Additionally, several online lenders offer lower credit score requirements, like Lendio and Creditfy. Each accepts a minimum credit score of 600 for SBA loans, compared to the minimum credit score of 650 or higher required by more traditional lenders, like Live Oak Bank.
To get an SBA loan, you apply through an SBA-approved lender. This will require extensive documentation, including personal and business financial statements, a business plan and SBA-specific forms, such as SBA Form 413 and 1920. Most SBA loans also require a down payment and personal guarantees.

Business lines of credit offer a more flexible borrowing option. They allow business owners to borrow as much or as little as needed, drawing on the funds as necessary. Like a business credit card, lines of credit come with a renewable spending limit, meaning the available credit is refreshed as you repay it.
Funds from a business line of credit can be made available relatively quickly, often within a business day, when working with an online lender. The money can cover business expenses, such as paying employees or purchasing inventory. But lines of credit typically come with smaller funding limits than traditional business loans, so they may not be able to cover significant expenses or funding needs.
You may also pay higher interest rates on a line of credit than other types of loans. Lenders aren’t required to display their rates for credit lines. But some may charge as much as 60 percent, depending on your creditworthiness.
Invoice financing and invoice factoring are similar types of short-term borrowing. Invoice financing involves using your business’s accounts receivables — unpaid invoices owed to your business by clients — as collateral to obtain a short-term cash advance. Once your client pays the invoice, you must repay the lender for the money you borrowed. You will also pay any fees for the loan.
Invoice factoring involves selling your business’s unpaid invoices to a third-party invoice factoring company. The factoring companies pay you anywhere from 85 percent to 90 percent of the value of the invoices. Once your client pays the invoice, the lender sends you the remaining amount after subtracting lending fees.
Both invoice financing and factoring can be valuable options for business owners with bad credit or for startups that do not have much of a borrowing track record yet. The downside to this level of accessibility is that these loans tend to cost more than term loans and lines of credit.
A merchant cash advance (MCA) is an advance against your business’s future sales, specifically debit and credit card sales. The advance is provided in a lump sum of cash, which you repay with a percentage of your future sales. The lender will also take its fees from your future sales.
MCAs are typically a short-term form of borrowing offered by online lenders. And often, you’ll pay a higher APR on cash advances than other types of business loans. It’s possible for interest rates to soar into the triple digits with MCAs, so business owners should proceed carefully before seeking out this type of business financing.
Approval for MCAs may be possible with subprime credit, sometimes as low as 500. But to qualify, you’ll need to provide details about your business and its track record of income from credit and debit card sales.
You can access small business loans through online lenders, banks, credit unions and peer-to-peer lending sites, with each lender offering various business financing options. The lender you choose is just one of many factors that impact the cost of your business loan, so you want to choose wisely.
If you’re interested in a small business loan from a bank, here are some banks offering business loans:
If you’re interested in a small business loan from an online lender, a few of your options include the following:

There are possibilities for small business funding outside of business loans if you aren’t able to meet lenders’ requirements. Two options include:

No two lenders are the same, meaning your odds of approval vary. If your goal is to get a business loan, you want to consider more than just the lender, loan type and loan amount.
You’ll also want to confirm each lender’s lending criteria to help you decide if your business qualifies. Although lenders use the information differently, loan approval for small business loans is often based on similar factors:
Before applying to a particular lender, research it to see whether your business can meet its requirements.
Apart from the qualifications listed above, business loans often require some or all of the following documents:
A business plan should outline your financial goals for the business, your strategies for reaching those goals and your ability to repay the loan. Effective business plans justify the need for funding, explain the amount of money requested and provide a clear explanation of how the funds will be used and how the loan will be repaid.
Small businesses have access to many loan options from a variety of sources. These loans work similarly to any other loan type. You’ll apply for the loan, receive funding once approved and work to repay the loan on a set schedule.
If you have a new business and are ready to take it to the next level, shop around and be open to different lenders, including online lenders, large banks and peer-to-peer lending sites. With so many loan programs available, it’s vital to research the requirements and interest rates before applying for a loan.

How to apply for a small business loan at a bank
What is a startup business loan? How does it work?
What is a business loan proposal?
Business loan vs. personal loan: What’s the difference?
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