A business loan can help you start or grow your business, but navigating the lending process, along with stricter lending standards, can be daunting. Break it down into manageable steps – from understanding qualifications to finding lenders and knowing how to apply for a small business loan – can help you get the financing your business needs.
1. Find out if you qualify for a business loan
What’s your credit rating?
You can get your credit report for free from each of the three major credit bureaus: Equifax, Experian, and TransUnion. You can also get your credit score for free from several credit card issuers and personal finance websites, including NerdWallet.
Banks prefer to offer their low-rate commercial loans to borrowers with a credit score of over 680 or more, says Suzanne Darden, finance specialist at the Alabama Small Business Development Center. If your credit score falls below this threshold, consider small business loans for borrowers with bad credit or loans from a non-profit micro-lender.
How long have you been in the business?
You must have been in business for at least a year to qualify for most online small business loans and at least two years to qualify for most bank loans.
Are you earning enough money?
Many lenders require a minimum annual income, which can range from $ 50,000 to $ 250,000.
2. Determine what payments you can afford
Take a close look at your business’s financials, especially cash flow, and assess how much you can afford to apply toward loan payments each month. Some online lenders require daily repayments, so be sure to take this into account.
To comfortably repay your loan each month, your total income should be at least 1.25 times your total expenses, including your new repayment amount, says Darden.
For example, if your business income is $ 10,000 per month and you pay $ 7,000 in rent, salaries, and other expenses, you should be able to afford a monthly loan of $ 1,000. Your income ($ 10,000) is 1.25 times $ 8,000 of expenses.
3. Decide if and how you want to secure the loan
A secured loan requires commercial guarantee, such as property or equipment, which the lender can seize if you do not repay the loan.
Providing collateral is risky, but it can also increase the amount lenders allow you to borrow and earn you a lower interest rate.
Lenders may also require personal collateral even for unsecured loans. This means that you will personally repay the loan if your business cannot, and that it can let a lender take care of things like your house or car if you default.
4. Decide on the type of loan you need to finance your business.
You want to manage current expenses. A business line of credit might make sense. This type of flexible funding allows you to tap into the funding needed to cover expenses such as payroll or unscheduled repairs, providing a useful safety net.
You want to grow your business. Supported by the government SBA loans or traditional term loans often have higher borrowing limits – SBA loans can be as high as $ 5.5 million, for example. Many lenders also offer specific products to meet the needs of a growing business, such as equipment loans or the purchase of vehicles.
5. Compare small business lenders
There are three main sources of small business loans: online lenders, banks, and not-for-profit micro-lenders. Each usually has multiple products, but one may be better in some cases than others.
When to get a business loan from online lenders:
You are running out of time in business.
You need financing fast.
Online lenders offer small business loans and lines of credit of around $ 1,000 to $ 5 million. The average annual percentage rate for these loans ranges from 6% to 99%, depending on the lender, the type and size of the loan, the repayment term, the borrower’s credit history and whether collateral is required.
These lenders rarely have APRs as low as those offered by traditional banks, but approval rates are higher and funding is faster than with banks – up to 12 hours.
When to get a business loan from banks:
You have been in business for at least two years.
You don’t need the money fast.
Traditional banking options include term loans, lines of credit, and commercial mortgages to buy property or refinance.
Through banks, the US Small Business Administration provides general small business loans with its 7 (a) loan program, short-term microloans, and disaster loans. The SBA provides loans of up to $ 5.5 million, with 7 (a) loans averaging $ 533,075 in fiscal 2020, according to the Congressional Research Service. The average SBA microcredit is $ 13,000.
The ASB also has a 504 loan program which helps promote the economic development of communities by financing the purchase of business capital assets – such as land, buildings or equipment – through long-term, fixed-rate financing.
Take out a small business loan from a bank can be difficult due to factors such as declining sales volume and cash reserves. Add bad personal credit or no collateral to that, and many small business owners come in empty-handed.
Obtaining financing takes longer than other options, but banks are usually the lowest APR option.
When to get a business loan from microlenders:
You have bad credit or no credit history.
You cannot get a traditional loan.
Micro-lenders are non-profit organizations that typically provide short-term loans of less than $ 50,000. The APR on these loans is generally higher than that on bank loans. The request may require a business plan, financial statements and a description of how the loan was used, making it a long process.
In addition, the size of the loans is, by definition, “micro”. But these loans can work well for small businesses or startups that cannot qualify for traditional bank loans due to limited operating history, poor personal credit, or lack of collateral.
Accion Opportunity Fund, Kiva and Accompany Capital are just a few examples of microlenders.
Estimate the cost of a business loan
Before applying, make sure you have all the required documents. Locating these files now and making them easily accessible will help streamline the process of getting a small business loan.
Depending on the lender, you will need to submit a combination of the following:
Tax returns for companies and individuals.
Professional and personal bank statements.
Company financial statements.
Commercial legal documents (eg articles of incorporation, commercial lease, franchise agreement).
7. Apply for a business loan
You did it! Now that you’ve figured out which loan type and lender is right for you, it’s time to apply.
Start by looking at two or three similar options based on loan terms and annual percentage rate, or APR. Since the APR includes all loan charges in addition to the interest rate, this is the best way to understand the total cost of a business loan for the year.
From the loans you are eligible for, choose the one with the lowest APR (as long as you are able to handle the regular loan payments) and apply with the documents you have gathered.
Note that the credit bureaus do not differentiate between business and personal inquiries. If you use your personal credit history, your credit score could be affected when applying for a small business loan, which is why it is important to choose your best bet.