Business Loan Types: Understanding Their Differences
When it comes to choosing the right loan for your business, it might be difficult and confusing. Even though you have a lot of options available, with proper research, you will find the best one for you. In this article, we will explain more about all the types of business loans and how to choose the right one.
Business loans have many different types to them, and choosing the right one for you is crucial. Whether you are looking for types of loans to start up a business or just to expand it, understanding their differences is a must. By now, you are probably wondering what types of business loans are there. We will give you and explain to you the types of business loans.
- SBA loans
- A business line of credit
- Term loans
- Invoice factoring
- Equipment loans
- Merchant cash advance (MCA)
- Working capital loans
- Personal loans for business
- Commercial real estate loans
SBA or Small Business Administration is in charge of issuing this type of loan that you can get directly from them or through banks and credit unions. The main thing you should know about SBA loans is that the repayment period depends on the amount you are looking to borrow and for what you need it. Usually, they range between 5 to 7 years for working capital, 7 to 10 years for buying equipment, and up to 25 years for buying real estate. Another key thing to know is that SBA loans offer six types of financing.
- 7(a) loans
- CAP loans
- Disaster loans
- Export loans
- CDC/504 loans
Business Line of Credit
A business line of credit (BLOC) is a very popular option amongst small business owners simply because you can borrow funds when you need them and return them later. They are short-term loans that, unlike traditional business loans, can be used to purchase supplies, inventory, or to pay any operation expense.
If you are in consideration of getting a business line of credit, you have two types to choose from. You have secured and unsecured business line of credit loans. The key difference between them is that with a secured BLOC, the lender will require collateral from you to secure the loan. On the other hand, the unsecured BLOC doesn’t require any collateral to be put in order to use it.
With that said, choosing the right option for you depends on what you need the money for, but remember that with an unsecured type, you might not get approved since the lenders find it risky. In order to get approved for it, you need to have a good credit score and an amazing track record of revenue.
If you are looking for short-term financing for your business, term loans can be a good fit for you. As mentioned, they are short-term loans that provide borrowers with a lump sum amount of cash upfront in exchange for very specific terms of borrowing. So, once you agree to take out a term loan, your repayment schedule can be with fixed or adjustable interest rates.
Like the business line of credit, term loans can be used as well for purchasing equipment, inventory, or any other fixed asset. Also, this type of loan requires you to put collateral to secure it. Some lenders might require from you a down payment, so be prepared for that.
In regards to invoice factoring, it’s crucial to understand that this is not a loan. When you request an invoice factoring, the company gives you the money upfront in 24 hours. Once you get the money, the company collects the payments from your customers by themselves. Once they are done with that, you get the leftover balance minus the fees.
With that said, invoice factoring has three groups.
- Primary factoring – The company gives the money to a business against its outstanding invoices. After that, the factor receives the invoice payments and pays the rest of the proceeds to the business.
- Secondary factoring – In this case, the factor gives the money to the business against the collateral. The repayment system is the same.
- Tertiary factoring – With this, the factor gives the money to a business against their debts or assets that they own or control. This can include raw materials or trade receivables.
When starting a business, one of the first things that you may need is equipment. This can include anything from computers to office furniture. In the end, whatever equipment you are looking to buy can put an enormous strain on your finances. That’s why a lot of businesses turn to equipment loans to get the needed funding.
As the name already suggests, it’s a loan that is used to buy all needed equipment to keep the business up and running and even to expand it. Once you take out this type of loan, you will need to make periodic payments that include paying the principal and interest rate over a fixed term. In the case of this loan, the lender will require collateral in the form of the equipment you are purchasing or even a personal guarantee. In case you are unable to repay the loan back, the lender recoups the assets to cover their loss.
Microloans fall in the subcategory of SBA loans. They are mostly used by small businesses, although businesses of any size can use them as well. If you are considering getting a microloan, they usually go up to 50,000$ as the amount you can borrow. It’s important to note that they are as well short-term loans that can have either low or high-interest rates, depending on the situation.
They work on the same principle as traditional loans; you borrow the money and then repay it back with interest over a set period of time. Most commonly, they are repaid back over the course of three to six years. You can apply for a microloan over SBA, USDA, online, or through alternative lending.
Merchant Cash Advances
Merchant cash advances have become increasingly popular over the years since they are very easy and fast to get. They are a great way to get quick, short-term financing for your business. They’re also a great option if you need money to cover expenses right away but don’t want to take out a loan. Based on the principle that you borrow the money and you repay it back through your credit card payments. Usually, it’s a daily, weekly, or monthly payment, depending on the agreement with the lender.
With that said, there are two types of merchant cash advances:
- Secured merchant cash advance
- A short-term loan, backed up by collateral, such as inventory or business account
- Unsecured merchant cash advance
As well short-term loan, but no collateral is needed. They are more expensive and are viewed as a riskier option.
Working Capital Loans
When starting a business, one of the most important things you need is working capital. This refers to the cash you have available to pay your bills and cover your operating expenses. Working capital loans have been designed to give the business the needed financing for everyday operations. This type of loan is not meant to be used as a long-term solution but instead is meant as a short-term loan that covers a short period of operational needs.
When talking about those needs, it can be anything like paying the rent, giving the salaries, or consolidating any existing debt. If you are in consideration of getting a working capital loan, remember that this loan is tied to the business owner’s credit score, so if you default on the loan, your credit score is going to get a huge hit.
Personal Loans for Business
If you are a small business owner or you are just looking to start your own business up, personal business loans are a better option for you in comparison to traditional business loans. They are much easier to qualify for than business loans, and you will have a fixed repayment term that can last from a couple of months to a couple of years.
Another key thing to know about personal business loans is that you are taking a loan as an individual, not as a business, so if you default on the loan, your credit score is going to suffer.
Commercial Real Estate Loans
A lot of people confuse commercial real estate loans with home loans. They are two very different things, simply because commercial real estate loan is the income-producing property that is only used for business purposes. Here are some examples of what we mean; office buildings and complexes, hotels, shopping malls, and retail malls. So once you take out this loan, you can use the money to develop and construct the up given examples of properties.
Like any other type of loan, you can get this through a bank or any other independent lender, and you will have two options to choose from.
- Secured commercial real estate loan – A lender will typically require that you put up a security deposit (which you can use to cover any damages caused by the loan) and agree to maintain certain levels of financial stability.
- Unsecured commercial real estate loans – They are less common but offer a number of advantages over secured loans. For example, unsecured loans don’t require any upfront security deposits and aren’t tied as closely to your financial stability.
How to Choose the Best Loan Type for Your Business?
When starting or expanding your business, there are many different loan types to choose from. However, it can be difficult to decide which type of loan is the best for your business. There are plenty to choose from, but not every loan will suit your business. If you are considering taking out a loan for your business, there are many factors to think about and include. The first one is how much money you are looking to borrow. If you are looking for a smaller amount that you want to repay back fast, you can go for micro-loans or merchant cash advances. On the other hand, if you are looking to expand and buy new equipment, you will need more money for that.
At the end of the day, all those factors are very important, and you need to calculate them in the process of making your decision. Our advice is to consult with a financial advisor before taking any loan out.
Successful business owners know that occasionally times can be rough and that their business is going to suffer. In a period like that, you can always turn to loans that are created for small or big businesses.
Orienting yourself in them can be hard, especially if you are new to them. That’s why here, in this article, we thoroughly listed and explained all the options you have available out there. We hope that this will help you find the best solution for you and your business.