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As a small business, you’ll often struggle with your finances. Even if you can cover your operational expenses, expanding, acquiring new equipment, and renovating will be quite difficult to pull off. For that reason, it’s important that you figure out where the money will come from.
Most commonly, funding comes from private means, regardless if it’s acquired by dipping into your savings account, selling an asset, or getting a personal loan. It’s far wiser, however, to go for a business loan, seeing as how this is literally what they were meant for.
The problem lies in the fact that there are so many different types of small business loans. Therefore, knowing which one is the one might be difficult. With that in mind, here are a couple of rules you should abide by to figure this one out.
Types of SMB Loans
Before making a definitive choice, you should inquire about different types of business loans and try to compare their features to your needs. Each has its advantages and disadvantages. Here’s how you can keep these things in check.
When you need a new piece of equipment or a hardware upgrade for your business, you might want to consider an equipment financing loan. This way, you’ll have more room to pick the perfect gear and improve your productivity drastically.
The way they work is fairly simple. They’re designed specifically for buying or leasing qualifying business equipment. The average term is 3 to 7 years and the lender is usually willing to finance anywhere between 80-100% of the total value.
It provides fast funding, gives flexible terms, and may lead to an increased credit score (if you pay on time). The problem is that they’re somewhat harder to qualify for. Moreover, since the loan term can be seven years, there’s a risk that they may surpass the useful life of the equipment in question. This is the most important thing you need to keep in mind.
Business lines of credit
This is probably the most flexible loan for businesses on this list. It works like a credit card – you get an approved amount and can draw from this credit line. You’re under no obligation to withdraw it all, and you’re only in debt for the portion of the money used.
The biggest advantage is that it’s flexible and may be used for short-term financing over and over again. If you’re a young business that still struggles with profitability, this can be used to cover your operational expenses (make up for what you’re currently short). All in all, it’s a catch-all short-term solution for your finances.
The problem with them is that they’re expensive. This flexibility is made up for the fact that the APR is usually significantly higher than with a traditional business loan. Moreover, the temptation is sometimes hard to resist.
Personal loan for business use
As we’ve mentioned in the introduction, nothing is preventing you from using a personal loan for business use. That is unless the lender is restricting the use of loans, which is not that common in loan terms.
First of all, it’s a lot easier to qualify for a personal loan. All you need is a decent credit score (for an unsecured loan) or a decent collateral (for a secured one). Keep in mind that this might be the best of ideas for sole proprietors, seeing as how, in the eyes of the law, your business and your finances belong to the same legal entity.
The downside is that you’re risking personal credit. Second, business loans usually have lower APR. Moreover, the total amount of money that you may borrow at one time will be substantially lower with a personal loan (it may not be enough).
Commercial real estate loan
A commercial real estate mortgage is not that different from a home mortgage. The differences lie in the fact that commercial loan-to-ratio value falls into the 65-80% range, whereas with residential loans, they’re as high as 100%. From the administrative point of view, these are issued to businesses, not individuals.
While some small and medium businesses may find this to be excessive, those with long-term plans might choose differently. Paying off a mortgage is, in many ways, superior to paying rent, especially if the location is convenient in the long run. Getting your own office space is a huge deal, and you want everything to be as perfect as possible.
Not all commercial loans are the same, and when choosing, you need to consider the terms that you’re getting, as well as your creditworthiness in the eyes of the lender. With these two out of the way, there are not many downsides to commercial real estate loans.
Now, keep in mind that, sometimes, purchasing office space is not the best course of action. What if you want to build your premises, either because your business has specific requirements or because you want to build a warehouse, parking lot, etc.? In this scenario, your best bet would be to go for a lot loan.
Now, before opting for a lot loan, it’s important to understand that not all land constitutes a lot. Raw land, improved land, and unimproved land are three separate categories, and they will affect the loan terms that you get.
The biggest benefit of a lot loan lies in the fact that you get the freedom of customizing the land in whatever way you see fit. The downside is that a land loan down payment tends to be quite significant, and these loans sometimes have higher rates than commercial real estate loans.
Sometimes you won’t need a lot and the idea of burying yourself in debt will seem illogical. In these scenarios, you need to consider microloans. These are the types of loans that provide a small amount of money, come with a high APR, and have a short repayment duration.
The biggest benefit of these loans is that they usually don’t ask for much paperwork or are too high of a credit score. They cover their risk through the fact that they have a much higher APR and the fact that they don’t stand to lose too much money.
These types of loans are ideal for those who need a one-time money injection and want to get done with this loan as soon as possible.
A term loan is almost the exact opposite of a microloan. It’s a loan that lasts between one and ten years (in some cases up to 30), and it involves an unfixed interest rate. While it’s not an ideal source of funding, it’s great for those who want to have as much money as possible with as low of a monthly credit payment as they can get.
The downside of this type of loan is that, by the end of it, you’ll pay far more than you’ve borrowed. Another downside is that, as an SMB, you already have too many account payables. The last thing you need is one more regular expense.
Keep in mind, nonetheless, that these loans are taken out of necessity. Therefore, comparing their terms to some other loans is not exactly fair.
The SBA loan is another loan with a much longer repayment rate. It’s usually issued by a bank and it has a huge range of loan amounts. You can get as much as $5 million, provided that you can get approved for such a loan.
It’s great for businesses with ad credit or no credit, and it will take you between 10 and 25 years to repay them. Seeing as how they require a long-term commitment, you need to do your research well before applying for an SBA loan.
How to Choose the Right Loan?
Before deciding on the type of loan you need, it’s imperative that you know exactly what you’re dealing with. More importantly, every loan comes with its unique set of strings attached and you need to try and figure out in what way these strings hinder your business.
Do you need it and how much?
First, ask yourself if this expense is so important that it’s worth applying for a loan. As we’ve mentioned earlier, it’s an additional expense for your business, probably at a time when you can’t spare more expenses.
Research the application process
Second, you need to figure out what kind of paperwork they require. Do you have to submit a business plan? How high of a credit score do you need? Do you need to have specific income-to-debt ratio collateral that will cover the risks?
Check interest rates
Interest rates are incredibly important, seeing as how they will determine how much more you’ll pay back. Keep in mind that the higher the risk, the higher the APR. Also, while shorter rates result in higher APR, you’ll end up paying more (cumulatively) with a longer loan term duration.
Check your credit score and collateral
Even if you don’t need a loan right now, you still might want to check your credit score and evaluate your collateral. Getting one of these loans and being responsible about repaying it may help you improve your credit rate.
In the end, if you have a specific expense (acquisition of new equipment, lot, office space), your first choice of loan should be quite obvious. Even then, you want to research your options and pick the best one for your specific situation. Remember, this is a long-term commitment, and you don’t want to be hasty when making the decision.