A good idea plays an important role in being a successful entrepreneur and small business owner, but it’s not the only requirement. Unless you have the means to self-fund, the first step is to secure a loan. But do you know how to choose the best one for your needs and objectives?
Editor’s note: Looking for a financing solution for your business? If you’re looking for information to help you choose the one that’s right for you, use the questionnaire below to get information from a variety of lenders for free:
If you don’t have any experience in the world of financing, then you probably don’t realize that there are many different types of loans. In fact, there are enough different loan types and formats to make your head spin. Before we dig into some tips and tricks for evaluating and choosing the right loan, let’s take a brief look at two of the most common types of loans, as well as the individual funding options within each category.
The Small Business Administration (SBA) offers different types of loans specifically for small business owners who meet certain requirements and qualifications. Here are the four major types:
If you are thinking about applying for an SBA loan, be prepared for the approval process to take a bit of time. To speed up the process, gather all your documentation before filling out the loan application. Many lenders that specialize in SBA loans are willing to walk you through the process, including Truist. Learn more in our full review of Truist.
SBA loans are great – if you qualify. However, traditional loans offer even more opportunities for people who don’t meet the requirements or need something more flexible. Here are some different types of traditional loans.
Alternative lenders are more willing than banks to work with business borrowers with challenged credit. You may pay more in interest as a result, but if the advantages of borrowing the money outweigh the costs, it may be worth it.
|SBA 504 loan
|SBA disaster loan
Is your head spinning yet? Those were just a few examples of small business loans – many more exist. Here are some recommendations for choosing the right loan for your situation.
Before you do anything else, spend time evaluating your business and how lenders see you. A quick credit check will help you understand your score, which is an important factor, but you also need to know your debt-to-equity ratio.
According to business consultant David Duryee, this is one of the most important metrics a lender analyzes. “It is a basic financial principle that the more you rely on debt versus equity to finance your business, the more risk you face,” he said. “Therefore, the higher the debt-to-equity ratio, the less safe your business [is].”
You obviously want to consider the interest rate, though this shouldn’t be the only determining factor. For example, if a $100,000 loan has repayment terms of five years, a difference of two percentage points really doesn’t matter that much in the grand scheme of things. It would, however, matter if the loan were for $1 million spread out over 20 years. Be smart about comparing interest rates, and give more weight to it when terms are higher.
Speaking of repayment terms, how much time do you have to pay off the loan? What does the payment schedule look like? Can you pay off the loan early, or do you have to wait until maturation? It’s easy for these to seem like tiny little details in the fine print of a loan, but they can save or cost you tens of thousands of dollars when it’s all said and done.
Are you aware that some lenders actually require you to pay to apply, while others don’t? Ask if any fees are associated with the application. Some lenders charge an application fee, while others charge fees for items tied into the application, such as the cost to run your credit report or get your collateral appraised.
You may feel like time isn’t on your side, but it’s OK to take things slowly. The absolute worst thing you can do is rush into this. Prematurely selecting a loan, only to figure out later that you chose the wrong one, can be devastating to your business. Be patient and carefully evaluate all of your options as you navigate the process.
Don’t feel rushed or pushed into a loan product. It pays to take your time and do your research to find the best business loan for your business. Compare lenders and read reviews before selecting the loan that is right for your unique situation.
Business loans come in a variety of types, with varying repayment terms and fees. When shopping for a loan, it’s always important to look at the annual percentage rate (APR). This tells you the total cost of the loan, including interest and fees. But that’s not the only thing you should consider when selecting a small business loan. Here are some other important factors to keep in mind.
The interest you’ll pay on your loan boils down mainly to your credit score. The lower it is, the more you will pay for a small business loan. If your credit score is in the mid to high 700s, you’ll get a better interest rate than if it’s in the low 600s. [Read related article: When Does Your Business Credit Score Matter?]
Many lenders provide flexibility regarding when and how often you pay back your loan. The longer the terms, the smaller the payments are, but the more interest you’ll pay. Conversely, the shorter the loan, the less interest you’ll pay. It’s important when selecting a small business loan to think about the monthly payment. You have to be able to afford it without dipping into savings or impacting cash flow. Terms can run from as short as three months to as long as 10 years.
Some lenders require you to offer personal or business collateral to back up the loan if you default. Known as collateral, it could include real estate, equipment, vehicles or other valuable assets. If you can’t pay back your loan, the lender can collect your collateral. Make sure you understand the collateral requirements and risks before agreeing to the loan. For example, our review of SBG Funding found that it doesn’t require collateral.
In lieu of collateral, some lenders require a personal guarantee. That means the lender can come after your personal assets if your business defaults on the loan. Many lenders require a personal guarantee in addition to collateral.
Depending on the lender you work with, you can have the money in your bank account the same day, within two to three business days or, in the SBA’s case, in a few weeks. Applying for a bank or SBA loan may not make the most sense if you need the money fast. We found through our research that Rapid Finance stands out as a fast-funding lender. Learn more in our Rapid Finance review.
Larry Alton contributed to the writing and research in this article.