Business Loans FAQs
Welcome to the Business Loans FAQs Page! Here we have answered some of the most frequently asked questions regarding small business loans, what they are, what they involve, and how you can apply for one. Click on any of the questions below for our answer. Don’t see a question that you’d like to see the answer to? Contact Us, and we’ll be sure to take a look at it!
Before You Apply for a Loan
When Applying for a Loan
What’s the difference between a traditional bank loan and an online, alternative lender?
A traditional bank loan is dependent on several factors, namely a person’s credit worthiness. Bank loans are available to both individuals and businesses alike. Banks and the loans they offer are heavily regulated by the government and can have strict rules that govern what and how they can loan. Alternative lenders are relatively new. These operate chiefly online and are alluring mostly to small-business owner. Alternative lenders use debt-based financing and are not backed by banks. Similarly, alternative lenders are self-governed and are therefore not subject to the rules and regulations banks must adhere to. Alternative lender loans are easier to secure, especially with those with poor credit, whereas bank loans have more stringent qualification processes and benchmarks.
The five C’s of credit are: Character, Capacity, Capital, Collateral, Conditions. Creditors use these to assess the degree to which potential borrowers are worthy of being granted a loan. Character has to do with the person’s reputation and credit; Capacity relates to the person’s ability to pay back the loan based on income versus debt; Capital is the amount of financial assets the person can put toward the loan; Collateral is a tangible asset the person promises to the lender as a form of loan protection; and Conditions include the interest rate and amount of principal that the lender will use to determine how much to finance.
What’s the difference between a merchant cash advance (MCA) and a term loan?
A merchant cash advance is common in small business loans. The MCA has short payment terms (sometimes as short as 24 months) and small payments that are often paid each business day. A term loan, conversely, has a floating interest rate and matures between one and 10 years.
Who qualifies for a microloan?
Though microloans are viable options for lower-income or even unemployed individuals, they are open to a wide range of people and business owners. To qualify, one must be at least 21 years old. If applying for business reasons, you must be the sole business owner or apply with co-owners as co-borrowers. A microloan for a business must be used for business loans only.
What is the lowest credit score I can have to get a small business loan?
For a business loan, your personal and business credit scores (if applicable) are taken into account. Lenders will typically accept a business credit score of 75 and above (based on 1 to 100) and a personal score of at least 640. Scores below these marks will make it very difficult to secure a loan for your business. Obviously, the higher your score, the greater your chances are of getting the best terms and rates for your loan.
What are the qualifications for a small business loan?
As you’ll recall, small business loans are furnished by the government. The Small Business Administration uses qualified lenders to supply these loans. The qualifications are:
- Income Tax Return—this is important to the lender because it is a track record of your income, which is a good indication if you will be able to pay back your loans.
- Resumes—past employment is an indicator of the kind of person you are. Resumes (including references) also provide the lender with an opportunity to interview your past employers to find out more about you.
- Personal background—this document(s) will include information like criminal backgrounds, previous employment, places lived, etc. Essentially anything that the lender feels is pertinent to getting to know what kind of person and business owner you are.
- Financial statements—again, this provides information about the kind of business owner you are. Lenders will usually want to know that you have more than 20 percent ownership in the business that you are applying for a loan for.
- Personal credit report—you may not think that your personal credit report is applicable, but to lenders your personal spending is just as important as your business spending.Business credit report—this will show the lender how well you have taken care of (and are currently taking care of) debt you already have.
- Collateral—small business loans are secured loans, which means they require collateral. The amount and kind of collateral will vary per lender, but you can plan on pledging some of your finances or property.
- Bank statements—lenders want to know how much money you are spending and where. This is an indication to them of where their money will be spent.Business plan—business plans are extremely important to lenders. If you have a sound business plan, the lender will know that you are a good investment. Lenders want to be assured that they will be able to get their money back, and they can predict this by the means of your business plan.
- Legal documents—this will vary per lender. Essentially, lenders may require further documentation of licenses, commercial leases, contracts, etc. Lenders want to know everything business-related that you have previously committed to and/or are currently involved in.
The items necessary for qualification can seem overwhelming, but small business loans are a good route to take. The lower interest rates and the security of small business loans are huge benefits to you as a business owner, especially if you are trying to start a company.
Should I only apply for one business loan at a time?
There is a myriad of options when it comes to securing a loan for your business—microloans, alternative lenders, and crowdfunding are just a few examples of such loans. Because there are so many different pros and cons; qualifications; timelines; and application processes for each kind of loan, it can be good to double up.
Perhaps the most important thing to consider is your financial situation. You need to able to understand your financial situation well enough to know that you can pay each loan back according to their stipulations and timelines. So what are some of the main things that you should pay attention to when applying for multiple loans at once?
- Interest rates: the interest rates are going to vary greatly from loan to loan. For example, traditional small business loans are going to have a much lower interest rate than those associated with MCA’s. (Merchant Cash Advances) When applying for multiple loans, (or any individual loan) carefully consider the amount of money you will end up actually spending on a loan. If you aren’t in a situation to be able to pay high interest rates, doubling up on smaller, secured loans is a better idea.
- Collateral: cross-collateralization is generally only available under the umbrella of a singular organization. For example, if you have a MCA through a lender as well as an equipment loan with that same lender, you can pledge the same collateral. But if you have one loan with lender A, you generally cannot use the same collateral for lender B. The reason for this is that if both loans default, the lenders would end up in a battle for your pledged property. Before providing a loan, creditors will often require documentation regarding the collateral you have pledged to other lenders.
- Financial history: the history of your payments on loans is a very important factor in deciding if you should apply for multiple loans; and if so, what kinds of loans. If you don’t have a good track record with paying off loans, new loans you secure will often have a higher interest rate. And if you add up several loans with high interest rates, it may be hard for you to pay them back, especially if you have struggled to do so in the past.
As mentioned before, each individual loan has its own pros and cons. Because each loan is different, doubling up on loans can be affordable and beneficial. If you do your homework, applying for multiple loans at once would be a great option for you as a small business owner.
Will my credit score be negatively affected if I apply for a business loan?
There are two kinds of credit scores: personal and business. Personal credit scores are calculated based on things like debt, lines of credit, history of credit, and new credit. They are measured on a scale of 300 to 850. Business credit scores are calculated based on things like loans, legal filings, and public records. They are measured on a scale of 1 to 100. The two types of credits can be similar and sometimes overlap when collateral is involved. In some cases, your personal credit score will be affected by applying for a business loan along with your business credit score.
One of these rare cases that your personal credit score could be affected by a business loans would be instances like using your home as collateral in a business loan agreement. Because your home is a personal asset and often purchased on credit, it is calculated into your personal credit score. If you choose to use your home equity as collateral in a business loan, that business loan can affect your personal credit score. This is also true of other personal collateral. If the personal collateral is tied up in a business loan, it will affect your personal credit score.
Another less frequent case in which applying for a business loan will affect your personal credit score is if you already have several business loans. The more loans you have, the more it will impact your personal credit score and business credit scores. This is because the sum of your debt is greater the more loans you have.
Though not technically a business loan, business debt can negatively impact your personal credit score. If you are purchasing materials for your business on your own credit card, those purchases will make a difference in your personal credit score.
Applying for a business loan will not affect your business credit score as much as your payment history on said loan does. The fact that you have applied to or even have a business loan matters, but whether or not that loan defaults matters more. If you are making payments on time for your business loan, it will be good for your credit score. Business credit scores are calculated on debt owed, and if that debt owed is being paid back on time, it will not negatively affect your business credit score very much.
Do business lenders look at my personal credit score or my business’s credit score?
Business lenders usually look at both your business and personal scores when applying for a business loan. For one thing, some applicants may be starting their first business and will therefore have no business score to speak of. In addition, your personal score will reveal much about your spending habits and ability to manage money.
What’s the difference between business collateral and a personal guarantee?
Business collateral, like personal collateral, is used in a secured business loan where you pledge a business asset to serve as protection for the lender in the event the loan defaults. If it does default, the lender can take possession of the business assets. With a personal guarantee, you are certifying that you will pay the debt from your personal assets if your business is unable. If the loan defaults, the lender can seize your business and personal assets.
For a more in-depth understanding of this topic, check out our BLOG POST!
What is a secured business loan?
A secured business loan is one where a borrower puts up some form of collateral against the loan. This can be in the form of business property such as the building or other business-related assets. Collateral protects the lender against loss in the event the borrower defaults on the loan. If this happens, the lender has the right to possess the collateral and sell it if desired.
What is an unsecured business loan?
In an unsecured business loan, the borrower offers no collateral against the loan. Instead, the loan is secured based solely on one’s credit. In these cases, interest rates are generally higher than in secured loans. The loan terms are also usually more stringent.
Can I get an unsecured business loan?
As you will recall, unsecured business loans are often called “signature loans.” This means that you can obtain the loan with a signed document without any collateral provided. However, unsecured business loans are often difficult to get. Because the borrower provides no collateral, the lender is going to make sure that the borrower can truly pay back the loan. They calculate the probability of loan being repaid based on the individual’s financial integrity, business record, and character.
Financial integrity is essentially living within your means. Lenders will look at your ability as a business owner to gain a profit instead of going into the red all the time. Financial integrity also includes budgeting. If you are able to successfully budget your money, a lender can be assured that you will do the same with the money that they will loan you. Lastly, when you have financial integrity, you track your spending. If you are a good bookkeeper, a lender will be able to see your past as a business owner and your ability to manage your money.
A business record generally contains all the basic information about your business. This includes expenditures, savings, equipment, employment records, and other such information. Lenders will definitely want to see your business record before giving you an unsecured business loan. This record is evidence of your ability as a business owner to take care of your company and make it grow. Because the business record is so important in obtaining unsecured loans, (as well as various other loans) it is in your best interest to keep a very detailed account of all your business dealings.
Character is essentially your reputation. If you are known as a good person and business owner within your community, you are more likely to get an unsecured loan. Things that a lender will look at in analyzing your character could include: how long you have owned a business, if you make your payments on time, how long you have kept employment, etc. Often times, a lender will conduct personal interviews with you before providing you with a loan. They do this to assess what kind of person and business owner you are, and whether or not you are trustworthy. Lenders have also been known to contact your previous employers, employees, and other individuals who have had business dealings with you in the past to find out what they think of you as an individual and business owner.
What if I can’t pay back my business loan?
When you can’t pay back your business loan in the agreed upon timeframe, it is considered a “defaulted” loan. There are several consequences to a defaulted loan:When a secured loan defaults, the lender has the right to seize the business and personal assets you pledged as collateral when you agreed to the loan terms. Once the lender seizes your assets, they have the right to do whatever they please with them, and in most cases, they will sell them.
When an unsecured loan defaults, the creditor will go after you for payment in either monetary or property form. Your creditor will hound you for a while, but eventually they will turn the pursuit over to a collections agency.While uncommon, a creditor can sue you for the sum that you owe. This is especially true if you owe a very large amount of money. Lawsuits can be very expensive, so most creditors will avoid lawsuits unless they are absolutely necessary.
A defaulted loan will have a major impact on your credit. Defaulted loans will cause your credit score to drop considerably, which will greatly affect your ability to secure a loan in the future.If your debt really starts to build up, you might come to a point that you have to declare bankruptcy. Obviously, this is your last resort as a business owner. If you default on an unsecured loan, bankruptcy will in general clear your debts. But if you try to declare bankruptcy based on a secured loan, the lender will still be able to seize your collateral.
The consequences of defaulted loans can become severe for you and your business. In all cases, it is better to take as many measures as you can to prevent a defaulted loan. If you recognize that there is the possibility that you won’t be able to make a payment on a loan in time, you should get in contact with your creditor right away. Often times you will be able to make an agreement to extend your deadline or make other arrangements so that you can avoid getting in trouble with your loan. Creditors know that it is in their best interest to get the amount you owe on a loan back, even if it means that it will take a longer time for them to get it back. It is much more profitable for lenders to get their money back from you rather than having to seize your collateral.
What is the difference between an interest rate and an APR?
An interest rate is an annual fee that you will pay on a loan. For example, if you take out a loan for $10,000 and have an annual interest rate of 4%, in a year you would pay $4,000 on top of the $10,000 owed. Interest rates are how creditors earn money. By charging interest, they earn more money than that which they lent. If it takes 3 years for an individual to pay $10,000 back, the creditor will earn a $12,000 and get the $10,000 they lent to the borrower returned to them.
An APR—or Annual Percentage Rate—on a loan is a calculation of annual interest rate, fees, and additional costs on a loan. Because of this, an APR will be higher than an annual interest rate because it is all inclusive. An APR is usually a more accurate measurement of how much you will be paying on top of your loan principle.
Some loans will have fixed interest rates while others will not. Whether or not the interest rate is fixed is dependent upon the agreement between a borrower and a creditor. Both parties will usually work to figure out what the best plan is for the borrower.
A fixed interest rate will stay the same throughout the duration of a loan. You will not have to worry about it fluctuating and paying an amount you weren’t planning on when you first signed for the loan.
An adjustable interest rate on a loan will change according to the market. Most of the time, the change won’t be drastic, but it will still be enough of a change that it will affect the amount of money you will pay on the loan. APR’s for adjustable interest rates do not account for fluctuations because they do not include the highest amount of interest that you will be paying. Therefore, if you agree to an adjustable rate loan, you need to take into consideration that neither the interest rate nor the APR will stay the same. A lot of times, creditors will set a “cap” for how high the interest rate can go, and even in some cases how low it can go. However, these caps are not universal for every loan.
When applying for a loan, it is important that you pay attention to both the interest rate and the APR. Both are important indications of how much you will actually be paying on a loan.