How Does A Business Loan Work? Business Owner Guide
Small businesses cover almost half of the private sector in the United States. They provide two out of every three jobs. If you also own a small business and need some funds for its growth, getting a business loan can be the best idea. It can help you in purchasing necessary equipment and meet any other financial needs.
Understanding the topic “how does a business loan work?” can help you find the right loan option according to your business needs.
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What Is a Business Loan?
A small business loan is one of the types of business loans which is specifically designed or articulated to offer financial help from traditional banks, online lenders and credit unions. The funds business get can be used to cover the business operational and business growth costs. For Example, equipment and real estate purchase.
How Does a Business Loan Work?
Now we will discuss how does a business loan work? Business loans are the source of financing for business owners either in the form of lump-sum payment or credit line. In return for this financial help, business has to repay the money it borrows plus interest and fees. Your lenders may ask for daily, weekly or monthly payments until full loan repayment. Period of repayment varies according to the type of the loan.
Additionally, business loans can be divided into two types:
- Secured Business Loans
- Unsecured Business Loans
Secured loans require something of value that a lender can keep if you fail to repay the loan. Something can include real estate, equipment, cash or investments.
Unsecured business loans don’t require any type of collateral or you don’t have to pledge anything in place of the loan you get for your business. Instead, you usually have to sign a personal guarantee which clarifies to accept personal liability if the debt is not repaid on time.
Uses of Business Loans
Business loans can be used for different purposes according to the needs. When you apply for a loan, usually it is necessary to show the lender how you will use the loan and for what purpose you are getting it. Here is the list of some common uses of business loans.
- Costs included in starting a business
- Commercial real estate purchases
- Cashflow for everyday expenses
- Debt consolidation
- Equipment or inventory purchases
- Business acquisitions
- Business expansion
- Business franchising
- Marketing and advertising of the business
You may notice that the most common type of purchase (personal expenses) is missing from the above-listed items. It means that the lenders will not allow you to use business loans for covering personal expenses like residence or home purchases, personal vehicles or any other type of transactions that are not related to the business.
How Hard It To Get a Business Loan?
As per the records of 2023, almost 51% of the applications for loans, and lines of credit of MCAs were considered as approved. Additionally, 28% of small businesses got partial approval for their funding amount.
Usually, possessing a better credit score can help you stand top of the list in loan approval, but it is also possible to secure a business loan even if your credit score is very low. But the disadvantage we face in this case is we have to pay higher average and interest rates.
How Much Collateral Is Needed For a Business Loan?
If you are willing to get a secured business loan or asset-based financing, the asset for which you are taking a loan serves as the collateral for the loan. The collateral is necessarily more valuable than the amount of the loan. For example, if you get a real estate loan, and you agree to get the loan up to 80% of the value of the property. The property itself is the collateral for the loan. It means that the collateral is 20% higher than the loan amount.
If you are going to pledge a more liquid asset, a lender might be more comfortable in funding you more than 90% of the collateral amount. Lenders may agree to offer a loan with a higher loan to value (LTV) ratio.
Some Types of Business Loans
There is a large variety of business loans present in the everyday market. Every type of the loan is dedicated to cover the specific type of needs. Here is the list of some common types of business loans:
- SBA Loan
- Term Loan
- Invoice Factoring
- Working Capital Loan
- Business Line of Credit
- Merchant Cash Advance
- Equipment Financing
Conclusion
Small businesses form a crucial part of the U.S. economy, providing two out of every three jobs. For small business owners looking to grow, securing a business loan can be an excellent solution. These loans can help with purchasing equipment, covering operational costs, and more.
Understanding how business loans work, including the types, repayment terms, and uses. Cahably can guide you in choosing the best financing option for your needs. Whether opting for a secured or unsecured loan, being informed will help you navigate the lending process more effectively and ensure the financial health of your business.
