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The vast majority of companies need a business loan at one time or another. You might need extra capital to get off the ground, start a new project, or expand operations. Business loans can also be used to finance equipment purchases, open a new location or build up inventory.
There are many different types of business loans, and the one that's right for you depends on your unique situation. Read on to learn a little more about the various types of business loans, as well as the interest rates you can expect to pay.
About Business Loans
Some of the most popular types of business loans include:
- Term loans: general loans used for a variety of purposes, including working capital and expansions. The loan is repaid on a monthly basis over a long-term period.
- Short-term loans: smaller loans that are typically repaid within a year. These are ideal for smaller purchases and investments or inventory acquisition.
- SBA loans: small business loans are financially backed through the U.S. Small Business Administration, making them more secure for banks and lending institutions.
- Equipment financing loans: loans to cover the cost of a specific piece of equipment. The equipment is put up as collateral and repossessed in the case of nonpayment. Because the equipment serves as collateral, these loans are among the easiest to obtain and tend to have lower interest rates than other types of business loans.
- Lines of credit: loans that make a certain amount of cash available each year for general business use. These loans are ideal for filling in the gaps during a temporary cash shortfall, but the interest rates can be high.
Business Loan Rates
Business loan rates are calculated based on the amount of risk the bank or financial institution believes it is assuming. Because business loans are considered riskier than home loans, for example, the interest rates are higher. They generally fall between 8% and 12%.
All lending institutions use what's known as the prime interest rate as a baseline, then add a percentage of the total loan value to the rate based upon the level of risk. Startups or young businesses will pay considerably more in interest than established, profitable companies.
The two most common sources of business loans are banks and third-party lenders. Banks tend to have lower interest rates but they're more selective about lending. Or, you can hire a business loan broker to research which lender is most likely to approve your application. That usually leads to greater success but you'll have to pay the broker for his or her services.
Applying for a Business Loan
Lenders base their decision on a number of factors, including credit, cash flow and other assets, collateral, and the business' past performance. Profitable companies that have been in business at least five or 10 years won't have much trouble obtaining a business loan. But startups and young businesses will have to work hard to convince the lender that their business model is sound.
Startups need to have a comprehensive business plan - in writing - and must be able to demonstrate a deep understanding of their industry. Many entrepreneurs turn to a business coach for advice in putting together a business plan and applying for a loan. Organizations like the U.S. Small Business Administration offer these services free of charge. Lending institutions may also require budding entrepreneurs to make a personal financial commitment, in addition to the loan.
Keep in mind that any business loan application you submit will be noted on your credit record. If one application is denied, other lenders will see that, making it even harder to get a loan. It's important to approach each lender with a comprehensive business plan to increase the likelihood of approval.