Finding money for your small business takes time. When you're choosing a business loan, understanding the associated terms makes it easier to understand what banks will need from you for the application. Read on to familiarize yourself with the terms you should know when looking for a small business loan.
How many years can you finance a business loan?
The best business loan and financing options for your business depend on your organization's unique needs. Each business loan is different, and the loan term depends on the type of loan you're seeking. Below are some examples.
|Type of loan||Loan term||Loan amount|
|Bank term loan||3-10 years||Highly variable|
|SBA loan||5-25 years||$350,000 on average|
|Short-term online loan||3-24 months||$5,000-$250,000|
|Long-term online loan||1-5 years||$5,000-$500,000|
|Merchant cash advance||3-18 months||$5,000-$500,000|
|Online invoice financing||30-90 days||Depends on your accounts receivable|
|Equipment financing||2-10 years||$100,000-$2 million|
|Line of credit||3-36 months||Highly variable|
Bank term loan (3-10 years)
Also known as commercial loans, bank loans typically have longer loan terms ranging from three to 10 years. If you use collateral to secure the loan, the terms could be as long as 20 years with fixed payments.
Term loans are usually a cheaper option because of the lower interest rates, but you must have good credit. Other options – such as 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 are prime plus 2.25% to 6.5%.
SBA loan (5-25 years)
The SBA works with banks, community development organizations, and microlenders to provide entrepreneurs the financing they need to start and grow their business. Several types of SBA loans are available, with SBA 7(a) loans, 504 loans and SBA Express loans being the most common.
OnDeck reports that SBA loan repayment terms are five to 25 years, and it typically takes 30 to 90 days for applicants to receive funding. The minimum loan amount is $10,000, but the average SBA loan is $350,000. Specialized programs may have different loan terms – like microloans. Since microloans are lower amounts, repayment is required in less than six years.
"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. These 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 more difficult to acquire than loans from noninstitutional 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.
Short-term online loan (3-24 months)
A short-term online loan has terms ranging from three to 24 months. The turnaround time to receive the funds from a short-term online loan is typically one or two days. Loan amounts range from $5,000 to $250,000.
Online loans are considered an alternative form of lending because the money is from nonbank lenders. Alternative lenders generally charge higher interest rates than traditional banks charge.
If your business doesn't qualify for a loan from a traditional bank, a short-term online loan may be a good option for you. 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 having to commit to one.
A short-term online loan is a lot like a Swiss Army knife, Blake said. "It's handy, flexible and able to get you out of a bind. 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 (1-5 years)
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 help you build credit, which you can use for future financing.
Long-term online loans may have higher interest rates because they are considered higher risks for the lender. However, eligibility may not be as restrictive when it comes to lower credit scores.
Merchant cash advance (3-18 months)
A merchant cash advance has terms ranging from three to 18 months. Loan amounts are $5,000 to $500,000, and funds can be deposited in your account within 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, so their turnaround time is faster than for other loan types. 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."
Online invoice financing (30-90 days)
Another financing option for business owners is online invoice financing – or termed accounts receivable financing. These loans are typically funded in about five days, but interest rates are usually higher than for traditional loans and the amounts vary.
This type of financing is different from other loan types, as you "sell" your unpaid invoices to a factoring company at a discount. It then collects the payment from your clients, which can take 30 to 90 days.
Equipment financing (2-10 years)
Equipment financing allows you 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. The finance program may also be offered under a rent-to-own type of lending arrangement.
Equipment financing loans can range from $100,000 to $2 million; loans can be funded in about five days. Repayment terms are two to 10 years, and no collateral is needed because the new equipment is the collateral.
Equipment financing interest rates may be higher than for traditional loans. This is the reason some companies use business loans to pay for new equipment.
Line of credit (3-36 months)
With a line of credit, the lender sets a credit limit, and you can withdraw the funds as needed up to that limit. You pay interest on the funds you use, not the full amount of your credit line.
The lender determines the repayment period, and the terms vary. Some lenders require you to make payments weekly over a three- to 36-month period, while others require monthly payments over a six- to 12-month period. You may not have a set payment period if you are granted a revolving line of credit.
Glossary of business loan terminology
You have many options when you need a loan for your small business. Each loan varies in 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 to help you 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 pay off your loan completely.
APR: "APR" stands for "annual percentage rate," which is the interest you will pay each year for the loan.
Assets: This is any property of monetary value that can be used as collateral – including 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 the borrower's assets if they can't 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 it may help save you money.
EBITDA: "EBITDA" stands for "earnings before interest, taxes, depreciation and amortization." Lenders use this calculation to examine your business's long-term financial health and determine its valuation.
Fixed interest rate: This is an interest rate that doesn't fluctuate with prime or index rates; a fixed-rate loan maintains a set rate for the entire 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 can't repay your debt – whether because of 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.
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. It 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: When you refinance a loan, 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; you can use them 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 a high-risk borrower. Subprime borrowers typically have a low credit score or 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 it assumes by allowing you to borrow money. 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 loan term 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 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 responsible for paying interest and other fees in addition to the loan.
When applying for a business loan, lenders have qualification requirements. Here are a few terms you should know beforehand.
- Credit score: Lenders use your business credit score to measure your creditworthiness and reliability, and determine if you're financially trustworthy to borrow money. 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 told to outline a financial plan for the money you intend to borrow. This helps lenders understand your plan for your company and assures them that you understand what is needed for your business to succeed. It also shows that you've researched your financial projections.
- Cash flow and income: Cash flow is the amount of money that goes in and out of your business over a certain period. Income is your company's total revenue, minus expenses. Lenders analyze cash flow statements and income statements to assess the risk they're taking by lending you money. The higher these figures, the more likely you can get approved for a loan.
- Age of business: This is how long your company has been in business. It's another factor lenders consider before deciding whether or not to approve your loan request. Many lenders require you to be in business for at least two years before they will lend you money.
- Collateral: This is an asset – like property or something else of value – used to secure a loan. The lender will seize the assets you put up for collateral and keep them if you fail to pay back the loan.
How do business loan terms affect your repayment?
Business loan terms have a sizable influence on the amount of interest you'll pay on your loan. Theoretically, the longer your repayment period, the more interest you'll pay. That's because interest compounds with time, meaning it increases in value with every passing second.
To minimize the impact of business loan terms on your repayments, read the fine print closely. Then, plug the numbers into a business loan calculator. You'll see your results in just moments. Compare the results from several loans to find the best option for your company.
How do you qualify for a business loan?
No two funding opportunities have the exact same loan terms and qualifications. That said, your chances of approval are highest if your business credit score is above 650. A high personal credit score can help, too, as can seeking funding for a business that's more than a year old and showing financial statements that indicate steady income streams. If all else fails, putting up collateral can be helpful. In fact, it's sometimes required.
What is the average rate on a business loan?
According to 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 is 2.48% to 5.4%, with small business loans averaging 5.96%.
Small business loan interest rates also depend on the loan type. For instance, alternative loan options – like merchant cash advances or invoice factoring – have higher annual percentage rates than traditional loans from banks or SBA loans.
Max Freedman contributed to the writing and reporting in this article. Source interviews were conducted for a previous version of this article.