The Top 4 Types of Business Loans of 2019
How do you decide which types of business loans are best for your business? If you are just starting to look at funding options, this article is for you. There are a few main types of business loans, each with their own requirements. We’ll look at the most common ones here.
Speaking of most common: Term loans are some of the most common and well-known types of business loans for 2019. Term loans help people finance everything from houses to heavy equipment (we’ll get there later). Term loans are usually what people have in mind when they say “loans.”
Though there are several variations on the traditional term loan, the basic principles remain the same:
- A borrower applies for a loan.
- Once approved, the loan funds are issued in a lump sum to be used for purposes the borrower has outlined in the application.
- The borrower then repays the loan over a set period of time, also paying an additional charge to the lender known as interest.
- Once the term has been completed, the loan is considered paid (in most cases), and the borrower is released from the liabilities of the loan agreement.
That all sounds relatively straightforward. But because of their simplicity, term loans may not always be the best choice for businesses. Limitations include:
- Strict lending policies. Loan funds can usually only be used for a specific purpose, as defined in the original lending agreement. Banks and credit unions arebound by very restrictive compliance requirements and other rules determined by government regulators. These can include limitations on the types of businesses they can lend to, or on the sizes of loans they issue.
- Longer wait times and terms. Applying for a traditional term loan can take a long time, especially for more complicated deals, or for businesses that are new or have less than perfect credit histories. Also, because there may be large sums of money involved, terms can stretch out for long periods of time, tying business owners to a financial product for years.
Most people are familiar with credit cards, but not everyone knows what lines of credit are and how the two differ. For business owners who need funding on a revolving basis, lines of credit can offer a much more affordable and flexible option than business credit cards or traditional loans.
Much like credit cards, lines of credit are approved for borrowers up to a set amount. The borrower can then draw against that line of credit until they reach their approved limit. They then repay those funds, with interest, until the borrowed amount is satisfied.
This sounds awfully close to how a credit card functions, and it is, but lines of credit differ in a few key areas:
- No cards are issued, and to receive funds, the borrower must go back to their lender and make a new request each time.
- Lines of credit, especially for businesses, can reach much larger sums of money than traditional credit cards.
- Most lenders require businesses to re-apply for their lines of credit periodically, which may be annually, or some other term as defined by the borrowing agreement.
Lines of credit are typically much more flexible and can provide funding more quickly than traditional term loans, but are not always used for the same purposes. Because a borrower has already been approved for an amount of money, the process to get funds from the lender is much faster than it would be if the borrower needed to apply and reapply every time they needed funding. Also, unlike term loans, lines of credit generally don’t have limitations on the use of funds. Most businesses use their lines of credit to bridge short gaps in revenue or to help fund a short-term project. Lines of credit are not typically designed to purchase large, expensive equipment or property, and shouldn’t be used in place of cash for everyday operating expenses.
Though technically under the umbrella of term loans, equipment loans are slightly different because of how they are issued and where they sometimes originate. Equipment loans are, just like they sound, used to purchase equipment. The funds are tied directly to the item or items purchased, and the equipment is generally used as collateral for the loan. This means that when the loan is approved, no money is issued to the borrower. If the borrower fails to repay the loan, the lender can seize the equipment to satisfy the loan agreement.
Equipment loans can also be issued by the manufacturer or retailer of the items being purchased. A great example of this would be a tractor or construction equipment dealer offering on-site financing to buyers. This can be a great option, as many times there are incentives and rebates that make the purchase of a particular brand of equipment much more affordable when financed directly through the dealer.
Short-term loans get a bad rap because of the stigma associated with payday loans for consumers; while much of their reputation is deserved, they aren’t always poisonous. Businesses that need smaller sums of money and that, for some reason, either can’t or don’t want to apply for a line of credit may pursue a short-term loan to fill in their financial gaps.
Loans are usually issued for much smaller amounts than traditional term loans and may be given to businesses that don’t have the best credit histories. As a result, short-term loans can be considered riskier by the lender, which means they may command higher fees and much higher interest rates. This can make them an overwhelming financial burden for business owners who have pursued short-term loans without having done the proper research.
So, which type of loan should you get?
No matter the type, consider these additional important factors:
- Lenders. Where you get your loan is as important as what kind of loan you’re getting. Different lenders have different abilities and policies that may allow them to offer lower interest rates, lower fees, or less restrictive terms and limitations. Beyond banks and credit unions, some online lenders specialize in business loans, and may be able to offer your business a custom loan.
- Business Financials. The financial state of your business and the “why” behind your decision to apply for a loan are crucial. Are you pursuing a loan to grow your operations and expand, or are you considering a loan to fill in the gaps in a weakening revenue stream? Loans can be powerful and strategic financial tools, but can also cause you great distress when used improperly.
- Other Options. Have you looked at alternatives to loans that might be better suited to your business? In some cases, taking on investors or using your own personal funds may be more responsible and effective ways to continue growing your business.