Business Loan Terms You Should Know

By Simone Johnson,
business.com writer
|
Aug 25, 2020
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Here are the business loan terms you should know before you apply for funding.

Finding money for your small business takes time. Understanding the terms associated with loans makes it easier to understand what banks will need from you when you are applying for a business loan. Read on to familiarize yourself with the terms you should know when looking for a small business loan.

What are the typical small business loan terms? 

Small businesses have many options when they need a loan. Each loan varies in terms of length, interest rates, and repayment requirements, so before you enter the world of small business funding, it's important to know the lingo. Here's a glossary of business loan terminology that will help you better navigate this process.

Amortization: When a loan is amortized, regular payments are scheduled until the principal sum and interest are paid off before the loan maturity date.

Amortization term: Also referred to as an amortization period, this is the length of time it takes to completely pay off your loan.

APR (annual percentage rate):  This is the amount of interest you will pay each year for the loan.

Assets: Any property of monetary value that can be used as collateral; examples of assets include real estate, equipment, stocks or bonds. 

 

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Balloon payment: This is a large sum of money paid to the lender at the end of the loan term. If a loan is not fully amortized over the loan term, there is a large balance remaining before the loan's maturity date that the borrower must pay.

Blanket lien: This is a lien that gives the lender the right to seize all of the borrower's assets if they're unable to pay back what they owe.

Consolidation: This is when you combine multiple loans into one loan, thereby eliminating multiple payment due dates and different interest rates. A consolidated loan establishes one due date, and if you qualify for a lower interest rate, may help save you money. 

EBITDA: This is an acronym for "earnings before interest, taxes, depreciation and amortization." It is a calculation used to help lenders examine your business's long-term financial health and determine your business's valuation.

Fixed interest rate: An interest rate that doesn't fluctuate with prime or index rates; a fixed-rate loan maintains a set rate for the length of the loan term.

Grace period: This is a set amount of time after the due date – usually 15 days – when interest doesn't accrue on your debt and you aren't penalized for late payments.

Insolvency: If you are unable to repay your debt, whether due to insufficient cash flow, excessive debt or other financial hardship, your business is insolvent.

Lien: This is a legal claim that gives the lender the right to seize assets that the debtor pledged as collateral if they default on the loan.

Loan-to-value (LTV) ratio: Lenders use this calculation to assess the financial risk of extending a secured loan to your business. It weighs the amount of the loan against the value of your collateral.

Maturity: This is the end of a loan term when the final principal and interest payments are due to be paid. 

Prepayment penalty: Lenders charge this fee to offset the loss of interest when the borrower pays down all or a large part of a loan before the loan maturity date. 

Principal: This is the amount of money borrowed in a loan. This does not include interest or other fees attached to the loan.

Prime rate: This is the interest rate that large commercial banks charge their most creditworthy borrowers (usually large corporations). It is based on the Federal Funds Rate, which fluctuates with the economy. 

Refinancing: This when you pay off a loan by taking out a new loan that offers better interest rates or longer terms, thus lowering your monthly payment.

Revolving line of credit: This type of loan allows you to borrow funds from a bank, repay them, and then repeat the process, as many times as needed, as long as you don't exceed your credit limit. Credit cards are an example of revolving credit: They can be used multiple times, as long as you repay the minimum balance regularly and do not exceed your credit limit.

Subprime borrower: This is an individual or business considered to be a high-risk borrower. Subprime borrowers typically have a low credit score or a poor financial standing and are less likely to be able to repay a loan. Because the lender assumes more risk in extending a loan to this borrower, a subprime borrower pays higher interest rates.

Underwriting: This is when a lender assesses the risk they assume by allowing you to borrow money from them. Underwriting is part of the vetting process lenders perform before they approve or deny a loan. 

Variable interest rate: Also called a floating interest rate, this type of interest rate fluctuates over the term of the loan in response to market interest rate changes.

Working capital: This is how much money your business has on hand to use for its day-to-day operations.

How many years can you finance a business loan? 

Each business loan is different; depending on the type of loan you're applying for, the loan term varies. Below are some examples.

Bank term loan

Also known as commercial loans, bank loans typically have longer loan terms, which can range from three to 10 years. Some term loans don't place onerous restrictions on how you should use the loan.

Term loans are usually a cheaper option when it comes to the cost of borrowing, with lower interest rates compared to other financing options, but borrowers must have good credit. Other options, like credit cards, have average interest rates of about 16%, according to Bankrate. However, according to the U.S. Small Business Administration, if you qualify for an SBA-backed loan, interest rates range from prime plus 2.25% to prime plus 6.5%. 

According to small business lender OnDeck, the average amount of time to receive funding is between 14 and 60 days, and the average loan amount is $500,000.  

SBA loan

The SBA works with banks, community development organizations, and microlenders to provide small business owners with the financing they need to start and grow their businesses. Several different types of SBA loans are available, with the 7(a), 504 and SBA Express being the most common. 

OnDeck reports that SBA loan repayment terms range between five and 25 years. It typically takes between 30 to 90 days for applicants to receive funding. The minimum loan amount is $10,000, but the average SBA loan is $350,000.

"Because each type of SBA loan is government-backed, many people erroneously assume the government is funding [the] small business loan," said Brock Blake, CEO and founder of Lendio. "Instead, the SBA guarantees the loans. This limits the risk for the lender and makes SBA loans more appealing to lenders."

SBA loans offer some of the lowest interest rates. SBA loan rates are influenced by the daily prime rate and a lender spread. The SBA caps the spread that a bank can charge borrowers based on the size and maturity of the loan. Although it's easier to qualify for an SBA loan than a traditional bank loan, SBA loans are harder to get compared to loans from non-institutional lenders. 

"They're known for being more paperwork-intensive, with a much longer time to fund and a higher percentage of rejection than direct online lenders," Blake told business.com. [Read related article: SBA 7(a) Loans: Program Details, and How to Apply]

Short-term online loan

A short-term online loan has terms ranging from three to 24 months. The turnaround time for a short-term online loan is typically one to two days from the time you apply for the loan to when you get the funds. Loan amounts typically range from $5,000 to $250,000. 

Online loans are considered an alternative form of lending, because the money is from non-bank lenders. Alternative lenders generally charge higher interest rates compared to the rates that traditional banks charge.

If your business does not qualify for a loan from a traditional bank, a short-term online loan can be a good replacement. You can get instant quotes and prequalification criteria without a hard credit inquiry. This helps you understand what kind of loan you qualify for without actually having to commit to one.

When it comes to short-term online loans, they're a lot like Swiss Army Knives, explained Blake. "It's handy, flexible and able to get you out of a bind," he said. "You can use it to cover unexpected costs, survive a slump, finance a short-term project, or even capitalize on a new business opportunity. It's definitely the loan you want in your back pocket."

Long-term online loan

Online lenders also offer long-term loans, with terms ranging from one to five years. It takes about two days to get approved, and loan amounts range from $5,000 to $500,000. You can use this loan for almost anything, and you aren't required to put up any collateral. Long-term online loans can be extremely helpful when trying to build good credit, which you can then use for future financing.

Merchant cash advance

A merchant cash advance is a short-term loan, with terms ranging from three to 18 months. Loan amounts range from $5,000 to $500,000; funds can be deposited in your account in as few as two days.

With a merchant cash advance, you're borrowing against your business's future earnings – the loan is repaid through a percentage of your credit card sales. These loans don't require collateral, which means the turnaround time for these loans is faster compared to other types of loans. Merchant cash advances are used by retail stores, restaurants, and other establishments with consistent credit card sales.

"A merchant cash advance is an option for startup businesses that may not yet qualify for other types of business financing," Blake said. "Because a merchant cash advance is repaid based on your business's daily sales, time in business, and other factors, things that usually make financing difficult for startups don't apply. If your startup has strong daily sales, a merchant cash advance could be an excellent solution for your fast capital needs." [Read related article: What Are Merchant Cash Advances and Working Capital Loans?]

Online invoice financing

Another financing option for business owners is online invoice financing, also known as accounts receivable financing. Loan amount vary from $100,000 to $2 million. These loans are typically funded in about five days, but interest rates are usually higher versus traditional loans. This type of financing is different from other types of loans, as you "sell" your unpaid invoices to a factoring company at a discount. It then collects the payment from your clients.

Equipment financing

Equipment financing is when you use a loan to buy or borrow physical tools or equipment for your company. For example, if you're a restaurant owner in need of an oven, equipment financing might be a good option for you.

Equipment financing loans can range from $100,000 to $2 million; loans can be funded in about five days. Repayment terms range between two and 10 years, and no collateral is needed, because the equipment you're using the money for is the collateral.

Line of credit

With a line of credit, the lender sets a credit limit, and you can withdraw the funds as needed, up to the credit limit. You pay interest on the funds you use, not the full amount of your credit line.

Repayment terms vary; the lender determines the repayment period. Some lenders require you to make payments weekly over a three- to 36-month loan term period, while others require monthly payments over a six- to 12-month period.

How does a business loan work?   

When taking out a business loan, you borrow money for your company that you must pay back to the bank or investor. You are also responsible for paying interest and other fees.

When applying for a business loan, lenders have qualification requirements. Here are a few terms you should know beforehand.

  • Credit score: Lenders use this score to measure the creditworthiness and reliability of your business, and if you're financially trustworthy enough to borrow money from them. [Read related article: When Does Your Business Credit Score Matter?] If you have bad credit or a troubled financial history (or no history at all), this doesn't mean finding funding is impossible. However, you may have to provide more documentation, and you will likely be charged higher interest rates. For example, you may be asked about your experience running your company or to outline a financial plan for the money you intend to borrow. This helps lenders understand what your plan is for your company and that you understand what is needed for your company to succeed. It also shows that you've researched your financial projections.

  • Cash flow and income: Cash flow shows you how much money goes in and out of your business over a period of time. Income reveals your company's total revenue, minus expenses. These are two factors that lenders analyze to assess the risk they're taking by lending money to you. The higher these figures are, the more likely you are to get approved for a loan. 
  • Age of business: This is how long your company has been in business and is another factor that lenders consider before deciding whether to approve your loan request or not. Many lenders require you to be in business for at least two years before they will lend money to you. 
  • Collateral: This is an asset, like property or something of value, that is used to secure a loan. The lender will seize the assets that have been put up for collateral and will keep it if the borrower fails to pay back the loan.

What is the average rate on a business loan?

According to data from the Federal Reserve's Survey of Terms of Business Lending, large national banks have a weighted average effective loan rate of 2.55% to 5.14%. Small business loans come in at 6.24%. 

For small national and regional banks, the weighted-average effective loan rate varies between 2.48% and 5.40%, with small business loans averaging 5.96%. 

Small business loan interest rates also depend on the loan type. For example, alternative loan options like merchant cash advances or invoice factoring have higher annual percentage rates than traditional loans from banks or SBA loans.

Simone R. Johnson was born and raised in New York City. She graduated from the University of Rochester in 2017 with a dual degree in English language media and communications and film media production. She has been a reporter for several New York publications prior to joining Business News Daily and business.com as a full-time staff writer. When she isn't writing, she enjoys community enrichment projects that serve disadvantaged groups and rereading her favorite novels.
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