Typical Business Loan Terms

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What do loan terms mean for the borrower?

Going through the application process for a small business loan is likely to leave even the most seasoned entrepreneur overwhelmed. Loan applications and approval processes consist of so much more than a simple verdict. The loan terms of business debt determine the amount of time it will take the borrower to be free of the debt as well as how much the loan will cost the business owner. Before reading about the average business loan terms and how you can negotiate better terms later in this article, let’s look at some basic loan vocabulary.

Annual Percentage Rate – The annual percentage rate (APR) of a loan is the cost to borrow money. APRs are different from interest rates because they include origination, processing, and any other fees for borrowing money.

Amortization – When speaking of business loans, amortization refers to the process of spreading the loan into payments to be made over a certain amount of time.

Factor Rate – Common with short-term financing options, like MCAs, factor rates are numbers that are multiplied by the outstanding principal to determine what the loan repayment will total.  For example, a factor rate of 1.20 on $100,000 will mean the borrower will end up paying $120,000 by the end of the term.

LTV – The loan-to-value ratio compares the amount of a loan to the value of an asset that a lien has been taken on. Stated asset back deals allow financing up to a 70% LTV, while full document deals allow up to 85%. Calculating the LTV can also give potential borrowers estimated monthly payments.

Typical business loan terms

In business lending, there are three main loan terms that accompany business loan options. The terms assigned to each type of loan are approximate because the exact number of payments a borrower will owe will be specified in the loan agreement after the borrower’s creditworthiness has been evaluated.

Short-term loan

Short-term business loans require that the debt be paid off in full or refinanced within 0-18 months. Short-term loans may include cash advance options, like bridge loans, merchant cash advances, microloans, and term loans.

Medium-term loan

Medium-term loan options offer repayment periods of 1-5 years and include term loans, lines of credit, equipment loans, and some SBA loans.

Long-term loan

Repayment terms of more than six years are considered long-term loans, which are typically term loans issued by a bank, credit union, or online lender. Long-term financing options may include commercial real estate (CRE) financing, bank loans, equipment financing, and SBA 504 loans.

Common small business loans and their estimated terms

Small business loan terms tell a borrower how long they’ll be making payments on a loan. Loan terms, or repayment terms, will depend on the lender and the type of business financing you’ve secured.

Merchant Cash Advance

A merchant cash advance (MCA) is a type of small business financing where the business owner receives a lump sum of money in exchange for a portion of the business’s future credit card sales. MCAs are not considered loans but give the entrepreneur access to funds based on future receivables. Cash advances are a great financial tool for small business owners that may be experiencing or anticipate working capital shortages due to inconsistent sales activity, unforeseen expenses, or a seasonal business model.

A merchant cash advance is not an ideal solution for long-term financing because they are typically more expensive than other types of loans. Since the advance is not considered a loan, there is no predetermined repayment schedule or interest rate. While the total amount repaid by a business is calculated using a factor rate instead of a fixed interest rate, most cash advances cost borrowers the equivalent of an annual percentage rate (APR) of 40 – 350%.  The high cost of MCAs deters some applicants, but Merchant Cash Advances can be a way to overcome a cash flow crisis or build better business credit history. Especially since eligibility requirements for MCAs are more flexible in terms of time in business and personal credit scores than other loan options.

Merchant Cash Advance – No fixed repayment term, considered short-term

Invoice Financing

Invoice financing and invoice factoring offer funding options to small business owners that have accounts receivable balances. They are a great short-term financing option for new business owners or borrowers with bad credit. Invoice factoring works when the business sells its unpaid invoices to a factoring company, where a factoring agent collects the invoice balances and reimburses the borrowing business with up to 95% of its balance. Invoice financing is a similar financing program where the business receives a line of credit using their unpaid invoices as collateral.

Invoice Factoring and Invoice Financing have no predetermined repayment terms

SBA Loans

SBA loans are a type of business financing where the loan amount is partially guaranteed by the U.S. Small Business Administration. The government backing makes these loans lower risk for lenders, so the borrower benefits by receiving lower interest rates, small down payment requirements, and longer terms. SBA loan funds can be used for startups, operating expenses, franchise financing, large purchases, expansion, and debt refinancing. SBA loans are available to small and medium-sized business owners through traditional lenders, like banks and credit unions, or online lenders, like Biz2Credit. There are several SBA loan programs, but some of the most common are listed below.

SBA 7(a) Loan – average term: 7-25 years

SBA 7(a) loans are the most common SBA loan program for small business owners and approve borrowers for loans up to $5 million. The eligibility requirements include three years of business income tax returns, a real estate schedule, and two years of personal tax returns for business owners.

SBA 504 loan – average term: 20-25 years

504 loans are good for entrepreneurs looking for long-term, fixed-rate financing to purchase or maintain major fixed assets. The SBA works with Certified Development Companies (CDCs) to approve these loans for for-profit U.S. companies with an average net income of less than $5 million.  504 loan funds can be approved for up to $5 million for a single project or up to $16.5 million for certain energy projects.

SBA Microloan – average term: 3-5 years

Microloans provide certain small business owners and nonprofit childcare businesses with loans up to $50,000 to cover startup costs or expansion costs. The Microloans are issued through pre-approved lenders that ultimately determine the interest rates and repayment terms. The maximum term for an SBA Microloan is six years.

Business Line of Credit

A business line of credit is a flexible financing option for small business owners. When a borrower applies for and is approved for a line of credit, they are approved for a maximum credit limit. Like a business credit card, the borrower can then draw on that credit line anytime they need fast funding. The repayment schedules for lines of credit include monthly payments of interest and principal. Business lines of credit are a great financing tool for entrepreneurs that are interested in growing an established business credit score because eligibility requirements are less strict than traditional bank loans.

Business line of credit – average term: 3-5 years

Term Loans

A term loan is a type of financing issued by traditional and alternative lenders. Term loans may be secured, where collateral or a personal guarantee is required, or they may be unsecured, where the borrower’s credit is enough to secure funds. Interest rates for term loans vary depending on the amount of the loan, the lender, the down payment, and the creditworthiness of the borrower. The interest rates may be fixed or variable, which fluctuates with market rates. Repayment terms including the number of payments required, interest rates, origination fees, and prepayment penalty are all provided to a borrower upfront, once their loan application is approved.

Term loan – average term: 2-10 years

Equipment Financing

Equipment financing provides funds for approved borrowers to purchase equipment necessary for their business. The type of equipment the loan is used for depends on the industry and business needs of the borrower but may include computers, vehicles, technology, copiers, commercial kitchen equipment, construction machinery, and more. The equipment, or asset, purchased acts as collateral on the loan so the interest rates on the loan are lower than other types of business loans. The term of an equipment loan is determined by the useful life of the asset making it possible for the loan to be repaid before the asset has fully depreciated.

Equipment financing – average term 5-10 years

How to negotiate the best loan terms

Business loan terms are based on several factors including the borrower’s creditworthiness, type of loan, lender, length of the loan, down payment, and any personal or government guarantee provided. However, loan terms are rarely set in stone. It is possible to negotiate the following terms:

  • Processing and origination fees – Some lenders and types of business funding options include processing fees, or loan origination charges at the start or throughout the term of a loan.
  • Personal guarantees – Business loans commonly require the business owner to add a personal guarantee to the terms, which states that if the business can’t pay back the loan, the owner will.
  • Prepayment penalties – Prepayment penalties charge the borrower a fee if they repay the loan ahead of schedule.
  • Interest rates – Interest rates can be negotiated and may be lowered with a different lender, higher credit score, or larger down payment.

Finding the best terms is important for a number of reasons, including being able to repay the loan faster, future credit history, monthly cash flow, and liability. To increase your small business’s negotiating power, try these tips:

Monitor your credit report

A better credit score gives the borrower more negotiating power with any lender. Monitor both the business credit and the personal credit score of the owner. Credit scores can be increased by paying bills on time, increasing annual revenue, increasing credit lines, and paying down or refinancing other business debts.

Add security

Unsecured business loans don’t require any collateral, but terms like interest rates and loan fees can often be lowered if the borrower is willing to make a down payment or add collateral to secure the loan. Collateral can be personal or business assets.

Choose the right lender

Repayment terms vary with each lender, so take some time to shop around for the best fit. Traditional lenders, like brick-and-mortar banks typically have the lowest interest rates, but the strictest approval requirements. Online lenders, like Biz2Credit, can typically offer competitive rates with a simpler application and approval process.

Final thoughts

Loan repayment terms cover the number of payments and the total cost the borrower has committed to. Short-term loans typically mature within 18 months, while long-term loans can have repayment schedules lasting 25 years. The term of a loan depends on the lender, type of financing, fees, and interest or factor rates. To negotiate the best rate, consider watching your credit score, adding collateral, and working with a great lender, like Biz2Credit.  Their lending specialists can help your business just like they were able to find the right business loan terms for Pradeep Saini to pull his business out of a financial crisis.

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