Applying for a Small Business Loan? Consider These 10 Things Before Making a Decision

Applying for a Small Business Loan: Key Things to Consider

1. Check for Annual Percentage Rate (APR)

While business owners are mostly aware of interest rates, they rarely pay attention to the annual percentage rate. This figure is always larger than the interest rate, and even inclusive of it along with other fees like loan origination, underwriting, etc. In case a loan product offers a lower interest rate but higher APR, this may indicate that the loan processing charges are very high and there are other fees involved. These charges are again spread over the entire loan tenure and covered in the loan amortization process.

2. Check for Hidden Fees

Where business owners usually prefer transparent and friendly applications, finding a loan offer that keeps everything transparent may be difficult. Certain lenders often include hidden fees like balloon payments, foreclosure penalty, part-payment penalty, interest rate hedging charges, etc. in very fine terms. Ask for these things clearly.

3. Fixed vs Variable Interest Rate

Interest rate also isn't simple. When applying for a small business loan, business owners may get the option to select between fixed and variable interest rates. Fixed interest rates keep monthly repayment predictable and are often the first choice of small business owners. However, the variable interest rate fluctuates with the market. With strong demand forecasting, businesses can apply for the variable interest rate. If the rate drops, they'll eventually need to pay a lower interest amount.

4. Your Credit Profile

A strong credit profile should translate to higher approval rates, and better loan terms. Consider doing a credit check. If you pay all your credit card bills on time and use a credit mix, you should generally have a decent credit score. As per Experian, lenders consider a score between 670-739 as good, 740-799 as very good, and 800-850 as excellent. Having a high credit score gives you more freedom to negotiate.

5. Take Care of Existing Debts

Loan experts usually recommend taking care of existing debts before applying for a small business loan. In case the debt is high, it might lower your debt-to-income ratio and affect the chances of securing business financing. Try closing existing debts with a lump-sum amount, or if possible, consolidate them under a single loan.

6. Prepare Strong Financial Documents

Launching a business without any business plan is like finding a needle in a haystack. Having a proper plan and strategy with a well-thought revenue model, business model, partnerships, and validated MVP may help you with securing a loan. Additionally, prepare balance sheets, tax returns, and other documents to support your income stability, and give a rough idea of how you plan to repay the loan.

7. Focus on Repayment Terms

This cannot be stressed enough. Monthly repayments should not feel like a jail sentence. They shouldn't limit the creativity and potential of your business by depleting your monthly profits. Look for repayment options like foreclosure, part payment, or even for shorter or more convenient loan tenures.

8. Secured and Unsecured Loans

In the loan industry, there are both secured and unsecured loan options. When you apply for an unsecured business loan, lenders may ask you to keep future receivables, commercial real estate, or some other business asset as collateral. This is because in case you default, lenders don't have a layer of protection to recover their damages. In contrast, in a secured loan, the equipment or product that you buy with the loan itself secures the loan.

9. Your Business Vision

Prioritizing things in a business is necessary. Try to figure out what you require first to get started or expand operations. It can be anything, like funds for equipment, inventory, white-labelling, marketing, etc. By having a clear path to achieve your business vision, you can apply for a business loan with appropriate figures in mind and plan faster exists.

10. Explore Multiple Loan Products

Don't fixate on a single loan product, like a term loan. Instead, identify what you need the funds for and what your current repayment capabilities are. By analyzing these, you can figure out whether you need a term loan, equipment loan, or just receivables funding.

Small Business Loan Options to Consider

Business owners applying for small business loans can choose from a variety of loan options available. Each loan option supports different stages of growth, depending on eligibility and financial needs.

1. SBA Loans

SBA loans are backed by the U.S. Small Business Administration and can be applied through sba.gov. These loans are best for for-profit organizations and offer lower interest rates and longer repayment terms for qualified applicants. The SBA 7(a) loan program can be used by business owners to fund property improvements, renovations, or working capital. It comes with the maximum loan amount of $5 million. For a shorter amount, businesses may opt for SBA 504 loans.

2. Term Loans

Term loans are traditional business financing options that offer a lump sum loan amount upfront. These loans can be repaid over a set period of time and come with predictable monthly payments and variable or fixed-rates. When applying for a small business loan, business owners can use term loans for one-time large investments such as equipment purchases, buying property, or funding renovations.

3. Equipment Financing

Equipment financing is a funding option designed for purchasing business assets such as tools, tech, or machinery. When applying for a small business loan, business owners can use equipment financing for purchasing kitchen appliances, POS systems, telecoms, power tools, computer hardware, and more. Here, the equipment itself serves as collateral, reducing credit approval difficulty.

4. Commercial Real Estate Loans

Commercial real estate loans help with property expansions, purchases, or leases. Small business owners can also use these loans to refinance older loans under better interest rates, freeing up working capital. The interest rates on commercial real estate loans may be comparatively lower than traditional business loans. Meaning, business owners can apply for these business loans with some peace of mind.

5. Business Line of Credit

A business line of credit is a flexible funding option that offers easy access to funds up to a pre-approved credit limit. Borrowers can draw funds when needed, repay, and use them again. It works like a credit card where interest is only charged on the used amount but often comes with lower rates. When applying for a small business loan, business owners can use a line of credit for short-term or unexpected costs during renovations.

6. Microloans and Nonprofit Programs

Microloans are another short loan amounts supported by the U.S. Small Business Administration or local nonprofit organizations. Budding entrepreneurs can use these loans to cover smaller expenses of their drive-thru startups or rural businesses.

Understanding the Actual Costs of Starting a Business

The business costs vary for every business idea. For example, certain businesses don't require any warehousing, like service-based businesses, freelance businesses, or dropshipping businesses. Such businesses can skip warehousing costs. Likewise, there exist asset-light business models that only require minimum capital to get started. However, with a defensive layer, like a payment-first business model (like in a gym setup), businesses may find it easier to manage working capital.

Common factors on which the cost of your startup may rely are:

• Business model
• Product offerings
• Commercial space required
• Equipment
• Raw material
• Finished goods
• White labelling
• Marketing
• Competition
• Licensing
• Staff
• Utility Bills
• Transportation and logistics

Pros and Cons: Applying for a Small Business Loan

Before applying for a small business loan, it's better to understand both its benefits and challenges. So, let's see.

Pros:

• Small business loans may offer quick funding decisions for property improvements, new equipment, inventory, and more
• They enhance creditworthiness through regular repayments
• They offer consistent working capital for ongoing expenses
• When applying for a small business loan, owners can choose from different loan programs for startups, established businesses, and rural diners
• Based on the usage and purpose of the loan, business owners may be able to get tax deductibles

Cons:

• The interest rate variations of small business loans depend on credit score and lender type.
• These loans require down payment for large loan amounts.
• Repayment obligations of small business loans may affect short-term cash flow.

Pro Tip: When applying for a small business loan, business owners can choose to work with a preferred lender or member FDIC bank. These provide reliability and faster funding. Also, many financial institutions now accept in-person or online loan applications for added convenience.

How to Apply for a Small Business Loan

Understanding how to get a small business loan increases loan approval chances. Here are the important steps to consider when applying for a small business loan:

Step 1: Assess Financial Readiness

Before applying for a small business loan, review your cash flow, debt obligations, and credit score. Also, determine your realistic repayment capacity. Do some market research and reach out to various vendors to figure out equipment costs, raw material costs, final goods cost, logistics, transportation, etc.

Step 2: Define Loan Purpose and Budget

Then specify how the loan amount asked will serve your business needs. When the funds are needed and for what purpose. Having a clear intent builds trust with lenders and will help you provide a complete roadmap for your business launch.

Step 3: Select a Loan Product

From multiple loan options available such as SBA loans, term loans, equipment loans, or line of credit, choose the right loan program. Also, compare interest rates and other fees related to the loan option.

Step 4: Check Eligibility Requirements

Since each lender follows unique eligibility requirements, it's better to check what your lender needs. So, be prepared with your annual revenue, ownership records, and repayment history documents. You can also consult a loan expert to understand the documents required.

Step 5: Gather Documents

Gather all the necessary documents such as tax returns, income statements, and proof of ownership. Also, ensure your checking account and business registration remain active.

Step 6: Submit Loan Application

Now complete the loan application either online or in-person through a preferred lender. After this, you can expect an evaluation of your credit and down payment capacity.

Step 7: Review Loan Offer and Repayment Plan

If your loan is approved, confirm all repayment schedules. Also, clarify the short-term and long-term rates with your lender to avoid confusion later.

Step 8: Negotiate

In the last step, you can try to negotiate the terms. Try asking for lower interest rates and flexibility in repayment.

Note: The aforementioned process is only for exemplary purposes. The actual process may vary for each lender.

The Bottom Line

Applying for a small business loan may set the foundation for your business. From SBA-guaranteed programs to microloans and term loans, each loan program serves different business goals. However, proper planning and understanding of how to apply for a small business loan make success possible.

For small business owners seeking expansion, now is the right time to explore financing options. Evaluate your business plan, gather documentation, and connect with a trusted lender. Your new startup could be the next local success story.