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What is a Business Term Loan and Do You Need One?

What is a Business Term Loan and Do You Need One?

December 30, 2019

If your business needs money, there are many ways to get it. The most traditional type of business loan is the term loan. It’s classic, simple, and easy to understand. They’ve been around for a long time and have helped millions of businesses get where they are today.

Check out how a business term loan works to see if it may help you.

Understanding the Business Term Loan

Just like a personal term loan, the business term loan has a fixed rate and fixed term. This makes it easy to budget each month. Most lenders offer business term loans with repayment terms between 1 and 5 years. The term you get depends on your qualifying factors including:

  • Your business credit score
  • The loan amount
  • Your ability to repay the loan

Of course, each lender has its own requirements too. The longer you borrow the money, the more interest you pay because you pose a higher risk of default. Most business term loans fund within a few days, as long as you provide the lender with everything needed upfront.

You should try and focus on the shortest term possible for your situation. If you take a longer term, look for a loan that doesn’t have a prepayment penalty. The sooner you pay off the loan, the less interest you pay, putting more money in y our business’s pocket.

How Can you Use Business Term Loan Funds?

Most lenders don’t dictate how you use your business term loan funds. A few common examples of uses include:

  • Expanding your business
  • Buying new equipment
  • Getting your hands on more working capital
  • Buying more inventory
  • Hiring more employees

Lenders may ask why you want the loan, but the reason typically doesn’t factor into the approval. As long as you can prove that you have the credit, income, and collateral to support the loan, the reason you need it won’t matter as much.

The Cost of a Business Term Loan

Every loan costs money, but how much it costs depends on a variety of factors.

  • How much money do you need to borrow?
  • What’s your credit score?
  • What’s your credit history?

Lenders base the loan’s fees on your risk of default. The higher the chances of you defaulting on the loan, the more fees you’ll pay. This is how lenders offset the risk of default.

Want a quick way to tell how much the loan will cost in its entirety? You can view it in a few ways. If you just want to know how much the loan’s interest costs annually, check out the APR. Want a full-blown evaluation of the loan’s costs? Add up the total loan interest, loan fees, and loan amount. You’ll get a true look at the loan’s total cost.

If you want a more broken down view, look at the average monthly payment. This is what you’ll pay monthly in order to keep your loan in good standing. It includes the principal plus interest. The fees are taken out of the amount you borrow at the onset of the loan.

Watch out for These Fees

We recommend that you get quotes from several lenders. As you shop around, make sure you truly know the fees charged. Some lenders lump the fees all together in one lump sum. That makes it harder to differentiate between the fees. How much are you actually paying? There’s little room for negotiation when they are lumped together.

Read the fine print on the disclosures too. Are there any hidden fees? A big one is prepayment penalties. Sometimes lenders charge a percentage of the loan amount if you pay it off before a certain date. Knowing this information will help you make the right choice.

Putting up Collateral

Business term loans almost always require collateral. Lenders have rights to the collateral should you default on your loan. Whether you use the equipment you’re purchasing, your home, or any other asset – you have to put something up for collateral which also factors into the loan’s cost.

Knowing Your Options

As you shop around, you’ll want to compare your offers. Since each lender has its own disclosures, it may be a bit difficult to manage. The Innovative Lending Platform Association makes it a bit easier with its SMART Box tool. SMART Box stands for Straightforward Metrics Around Rate and Total Cost. It evens out the metrics, helping you effectively compare loans with different APRs.

Of course, no tool is 100% foolproof. The best method is to use the tools as complementary, but to do your own research and truly dig into the cost of the loans.

Choosing the Right Loan

After you receive quotes from several lenders, it’s time to make a decision. You’ll need to choose one lender to submit your application to, which also means gathering all of the necessary paperwork. While each lender differs, expect to need at least the following:

  • Personal identifying information including all previous addresses
  • Proof of your education history (proof that you have what it takes to succeed)
  • Credit reports (personal and business in some cases)
  • Income documents (tax returns and P&Ls)
  • Bank statements for both personal and business use
  • All business income documentation
  • Proof of your ability to do business (licenses)
  • Any legal documents
  • Lease documentation

Check with your chosen lender to see what documents they need. Each lender will have different requirements amongst borrowers too as each business and person is different.

Lenders need to know beyond a reasonable doubt that you can afford the loan and that you have what it takes to succeed in business as this all determines the riskiness of your loan.

Submitting Your Application

The final step is to submit your application. This is when the underwriting process begins. Lenders start by looking at your credit – both personal and business. They pay close attention to your scores. The lower your scores are, the higher the risk of default you pose. Depending on the scores, lenders may increase your down payment requirements, increase the fees, and/or interest your interest rate.

Lenders use your personal credit score to get a feel for your ability to repay your debts. They then put more focus on your business credit score. This is where they want to see your ability to succeed in business. They look at things such as:

  • Your experience (years in business and/or in the industry)
  • The value of your collateral
  • The stability of your business plan
  • The stability of your business finances

Dealing With Denied Applications

It happens to the best of us – lenders turn loan applications down every day. Don’t get discouraged at the first or second denial. However, if you find yourself with numerous declined applications, it’s time to figure out why. Start by checking out your credit scores.

Your personal credit scores are made up of the following:

  • Payment history
  • Outstanding balances
  • Length of credit history
  • New credit
  • Types of credit accounts

The higher your personal credit score, the more doors that will open for you. Even if your business is on the newer side and doesn’t have a lot of established credit, your personal credit score can offset the risks that poses.

Fortunately, there are easy ways to fix your personal credit score. After evaluating why your score is lower than lenders would like, try the following:

  • Get current on your payments (late payments have the largest negative effect on your score)
  • Lower your debt (try to get your outstanding debt at 30% or less than your credit lines)
  • Mix up your credit (if you only have revolving debt, try and mix it up with installment debt too)
  • Don’t close old accounts (even if you don’t use them, just leave the accounts open)

As a business owner, you should always be working on both your personal and business credit. You never know when you’ll need a term business loan to help you fund an immediate need or to grow your business. A term loan offers the most predictability, low fees and low interest rates, making it a great option for new and established small businesses that need a little extra capital.

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