In this article, youâll learn:
- Typical business loan terms for business owners
- Best practices before signing a loan agreement
- Types of business loans
So, youâre applying for a business loan and seeing a lot of business loan terms in the loan agreement. The interest rate and monthly payment are probably the two things that jump out at you, but itâs important to not overlook the other pieces of the puzzle, as a loan with a low interest rate and low monthly payment isnât always favorable to the borrower.
By understanding typical business loan terms and carefully reading your loan agreement, you can make an educated decision on your business loan.
Here are some of the typical business loan terms for business owners, presented in alphabetical order:
The term âamortizationâ refers to two situations â one concerns intangible assets and the other concerns business loans. Weâre going to focus on the latter in this section.
In the business loan context, amortization is the process of making regular payments â split between interest and principal â that allows the borrower to repay the loan in full by its maturity date. In the early days, a higher percentage of each payment is attributed to the interest portion of the loan. But towards the end of the loan repayment term, a higher percentage of each payment is applied to the principal portion of the loan.
You may be wondering: why does it work like that?
Over time, the interest portion goes down because youâre paying down the principal with each payment. For example, you have a loan for $100,000 and each payment is $2,000. The first payment is $500 principal and $1,500 interest. This reduces the ending balance to $99,500. The interest on $99,500 is lower than the interest on $100,000, so the next $2,000 payment is going to be more than $500 in principal and less than $1,500 in interest.
Annual Percentage Rate
The Annual Percentage Rate (APR) of a loan is the yearly rate charged for a loan â it factors in the interest and fees to be paid over the life of the loan.
Hereâs how it works:
You add the interest and fees, and then take that amount and divide it by the principal. You divide that result by the number of days in your loan term, multiply by 365, and then multiply by 100.
APR is an excellent way to make apples-to-apples comparisons between loan products, as a low interest rate can be deceiving if it is accompanied by high fees.
With some types of loans, your payments are split between interest and principal. But in other cases, you make interest-only monthly payments throughout the life of the loan and pay off the principal in one lump sum payment at the end of the life of the loan. That one lump sum payment is referred to as a balloon payment.
A blanket lien gives a lender the right to seize all of a borrowerâs assets in the event of a default. In a vacuum, a blanket lien is very unfavorable for borrowers. But if youâre a âriskyâ borrower who is struggling to qualify for a loan or youâre getting offered a much lower interest rate in return for agreeing to a blanket lien, it may be worth considering.
The term collateral refers to a business asset, such as real estate, a vehicle, or equipment, that the lender is allowed to seize in the event of a default. With collateral, you increase the likelihood that you qualify for small business financing and secure attractive small business loan terms.
If you default on a loan, it means that you didnât fulfill your obligation to repay the loan. At that point, the lender can take legal action against you, depending on the terms of the loan agreement.
A factor rate is used to express the total repayment amount on a short-term loan or merchant cash advance. You multiply the loan amount by the factor rate to get the total repayment amount. For example, you have a loan amount of $40,000 and a factor rate of 1.25. In this case, you would be on the hook for $50,000.
Interest-Only Payment Loan
With an interest-only payment loan, your monthly payment depends on the interest rate of the loan. At the end of the life of the loan, you either pay off the principal in one lump sum payment or refinance and get a new loan.
If youâre taking out a loan to finance a specific asset, such as new equipment or commercial real estate, you should calculate the loan-to-value (LTV) ratio â this ratio represents what percentage of the asset is covered by the loan.
For example, you want to buy a new piece of equipment for $50,000 and you have an opportunity to get a loan for $40,000. In this case, the LTV ratio would be 40,000 / 50,000 = 0.80. The ratio is usually expressed as a percentage, so it would be 80% in this example.
If you have a new business, a bad business credit score, or no valuable assets on your balance sheet, a lender may require you to provide a personal guarantee to get access to a loan. With a personal guarantee, the small business owner puts their personal assets on the line in the event of a default. While agreeing to include a personal guarantee may be the only way to get a loan in certain situations, you should carefully consider the consequences.
If your business exceeds expectations, you may be in a position to repay your business loan ahead of schedule. But some loan agreements include prepayment penalties to compensate lenders for the loss of interest if this scenario comes to fruition. You should try to get a loan without prepayment penalties, but if the lender insists on including them, you should at least be comfortable with the penalty amounts.
The principal is the amount that you borrowed for your small business, excluding interest. So, if you borrowed $50,000 to meet working capital needs, your principal is $50,000.
If you refinance your debt, it means that you pay off one loan with another loan. The opportunity to get a lower interest rate or extend the length of the repayment period are two common reasons for a borrower to refinance a loan.
Type of Interest Rate
When borrowing money via a loan, there are two types of interest rates: fixed and variable. With a fixed interest rate, the interest remains the same throughout the life of the loan. With a variable interest rate, the interest rate could change at some point â this change has the potential to significantly impact your monthly loan payment, so you should determine when and how much the interest rate is going to change before signing the loan agreement.
Best Practices Before Signing a Loan Agreement
Here are a few best practices before signing a loan agreement to lower your risk of running into trouble:
- Check whether the loan going to be under your personal name or your business name. If itâs the former, your personal assets are going to be at risk in the event of a default. If itâs the latter, you may be able to limit your liability to your business assets.
- Budget the monthly payments. You should project the future cash flow of your small business and see if itâs going to be enough to cover your monthly payments. Ideally, you are going to have a cushion to account for unexpected developments. For example, you wouldnât want to take out a loan with $1,000 monthly payments if you project your cash flow to be $1,050 a month.
- Ask the lender any questions. If youâre unsure about anything in your loan agreement, ask the lender for clarification.
- Have a lawyer review the loan agreement. After reading this article, youâre going to have a strong understanding of typical business loan terms. But itâs still possible you overlook something crucial â that could be costly if youâre taking out a large loan. With that in mind, you should look for a lawyer who specializes in reviewing small business loan agreements.
Types of Business Loans
Here are a few loan types for small business owners:
SBA 7(a) Loans
The U.S. Small Business Administration (SBA) is a federal agency that provides loan guarantee programs for small business owners, many of whom are unable to get traditional bank loans. The SBA 7(a) loan has a maximum loan amount of $5 million, making it a great loan option for expensive business assets. In addition, the guarantee artificially lowers the interest rate, giving small business owners access to low-cost financing through SBA loans.
While an SBA loan sounds like a great option, itâs tough to qualify for this type of financing due to stringent eligibility requirements. On top of that, the loan application process and review process could be lengthy â you might have to wait months to get an approval or denial decision.
With a term loan, the borrower gets upfront cash to be repaid on a set schedule at a variable or fixed interest rate. The loan amounts start at $25k and go up to $500k, so they can satisfy a variety of business needs. With payment plans ranging from 12 to 36 months, you should be able to find a monthly payment that works based on your cash flow projections.
There are usually high standards to qualify for a term loan. At Biz2Credit, most customers get started with annual revenue greater than $250k, a 660 or higher credit score, and at least 18 months in business. Hereâs the good news: you may be able to get financing in as little as a few days â particularly if you use an alternative lender.
Business Line of Credit
A business line of credit is a predetermined amount of money that can be accessed by the borrower when they need the funds â it can be used for general business expenses, further increasing the flexibility of this small business financing option. A business line of credit often has a variable interest rate, however, so you should find out how the interest rate is going to be calculated.
While you may not be able to qualify for a business line of credit with bad credit, itâs not too hard to meet the eligibility requirements with many online lenders. A 580+ credit score, 12 months in business, and $10,000 in average monthly revenue may be sufficient.
The Bottom Line
By understanding the typical business loan terms, you can increase the likelihood you take out a loan that fits the requirements of your small business.
But you donât want to wait months to get approved for that loan, which is still the reality at many financial institutions â itâs not the reality with Biz2Credit, however. We help small business owners get access to funds in as little as a few days.
Jyoti Sharma, for example, wanted to immediately open a spa but the banks told her that it would take them 2-3 months to get her funds. So, she decided to turn to Biz2Credit, and she got access to credit at a similar rate to the banks, but with a much shorter wait and less paperwork. Sharma recalled, âBiz2Credit came in like a lifesaver.â
Learn how Biz2Credit can connect you with small business financing.