What you need to know about small business loans
Finding the right loan to finance a new business idea or to grow an existing business can be tricky. Business owners rarely have hours of spare time to spend researching every choice available so deciding on a lender can be daunting.
Finding the right loan for your individual business takes time and effort which no doubt can be better utilised acquiring new clients or customers. Here’s a quick guide on what you need to know about small business loans so that you can decide whether this route is right for you and your business.
If you’re ready to compare business loans, our free service lets you compare loans from over 70 lenders—both big and small. You can get approval in as little as 24 hours, apply for any amount between 5K and 20M, and receive funds straight into your account once approved.
There are many reasons to pursue small business ownership, from wanting to share an idea or invention with the world, to simply desiring the lifestyle that comes along with working for yourself.
But one major thing that becomes obvious when starting or growing a business is that it takes money to make money.
This may be more apparent with large ventures that need physical space, inventory or equipment. But even small service-based or home businesses will have upfront costs.
After reading this quick guide, you should have a better understanding of how small business loans work, the different types of loans available, and what eligibility criteria you’ll need to meet in order to be approved.
What is a small business loan?
A small business loan is a set amount of money borrowed by a business owner from a financial institution. It is repaid, with interest, over a predetermined period (usually between one and five years) until the loan is paid in full. There are a variety of business loans available which we will go through.
Generally, a small business owner will be able to borrow from $5,000 to $250,000, though some credit providers may offer more. The amount available to borrow is determined by looking at things like size, age, and revenue of the business.
What can a business loan be used for?
A business loan can be used for many things, including:
- Purchasing necessary equipment
- Purchasing stock
- The costs of acquiring a physical space to work from
- Business expansion
Katie’s artisanal soap business has really taken off in the last year. She needs to move the business out of her home to a dedicated workspace and employ someone to help work through the orders.
She doesn’t have the capital to expand but feels that this is a good indication of growth and where the business could go in the future.
A $30,000 loan enables her to lease a new space, purchase extra inventory and employ someone part-time. The combination of the right timing and a flexible loan amount allowed Katie to take her business to the next level.
Adding a physical workspace to a home business comes with a lot of expenses on top of the upfront cost. It’s essential to do a thorough cash flow analysis to ensure the added overhead is worth it.
Finding the right loan for you
It can seem like there are hundreds of lenders out there offering you the perfect loan for your business. But each loan or credit option comes with a degree of risk vs reward, different features, and varying interest rates.
Business loan offers can be filled with complex wording and specific conditions. Taking time to research each option will allow you to make the best decision for your financial health. Or, you can let us do the shopping for you.
Variable vs Fixed Interest Rates
The interest rate is an important factor to check when it comes to business loans. There are two types of interest rates—variable and fixed.
Fixed interest rate
Fixed interest means the interest rate given at the start of the loan will remain the same for the entire term of the loan. You will know exactly how much your repayments are every month and can prepare for this.
Having this information and the exact date the loan is due to be repaid (provided the repayment schedule is followed) can give you peace of mind from the outset.
A fixed-rate could allow you to have tighter control over your finances, setting up a long-term budget to stick to creates a sense of stability in the business.
Variable interest rate
A variable interest rate will change according to the market conditions, so the interest rate given at the start of the loan may change at any point over the term of the loan.
This means you could end up paying a lower interest rate if the market changes, but you also could end up paying more if the average market rate increases.
Even a small increase in interest rates may cause an unexpected expense for your business. On the other hand, if you feel your business has enough financial security for a variable loan rate, it could end up saving you money.
Types of business loans
- Line of credit
A business line of credit approves you for a particular credit limit that you can use as and when needed. It’s a little different from a standard business loan which gives you a set amount of money upfront.
You can access the credit as and when you wish, and you are only responsible for paying back what you use, plus any fees stated by the lender. Interest is only charged on the amount that is used, not the entire amount approved.
It functions more like a credit card than a traditional business loan but generally offers lower rates than standard credit cards. If your financial needs fluctuate a line of credit can give you fast and flexible access to business funding.
- Business Overdraft
You can apply for a business overdraft on your business banking account to allow you to overdraw to a certain limit. Fees often apply.
Withdrawals can be made when the account is empty, but it all needs to be repaid, and interest is charged on the amount of credit used.
A business overdraft offers flexibility in your cash flow and can be useful for businesses with temporary or seasonal workers. It allows you to pay your employees even if you’re waiting on payments from clients.
- Term loan
This is simply a set amount of money borrowed from a bank or other financial institution which you must repay over an agreed period. It either comes with a fixed or variable interest rate and a set date when the loan will be paid off.
The term loan is one of the most common forms of credit.
- Invoice financing
Invoice financing companies purchase outstanding invoices for a large percentage of their total value while keeping a small sum of payment for themselves.
This can be a good option when you can’t wait weeks for clients to pay your invoices and need the cash flow sooner.
- Business credit card
These work similarly to personal credit cards, but you can add multiple cardholders, and it is only used for business purchases.
Business credit cards can help you meet immediate cash flow needs and often generate benefits from reward programs. An interest-free period is usually offered, but after this, the interest rates can be high.
- Equipment finance
There are many equipment finance options to help you purchase or lease the equipment needed for the business. These include commercial loans, equipment hire purchases and finance leases, so you’ll need to research to decide which is right for your business.
These loans typically have a maximum loan amount of $30,000. Anything higher might require business owners to provide the details of their trading history.
- Peer-to-peer business loan
Peer-to-peer lending matches people who have money they want to invest with people looking for a loan. The money can come from a single investor or a pool of people.
Eligibility criteria will need to be met, but these loans are relatively easy to apply for. Interest is charged and the broker setting up the loan typically charges a fee.
Considering each aspect of any loan before borrowing is vital to keeping on top of your finances.
The full cost of a business loan
Consider these three factors to ensure you know, and are comfortable with, the total cost of the loan:
The loan amount: A larger loan will mean larger repayments.
The interest rate: A higher interest rate means you’ll pay back more money in the end. Decide whether you want the stability of a fixed interest rate or the possible savings that could come with a variable interest rate.
Any applicable fees or charges: Read the terms and conditions of the loan to be aware of any upfront or ongoing costs.
Fees to look out for
- One-off fees like application fees
- Exit fees
- Early termination fees
- Ongoing fees like service fees or annual fees
Is my business eligible for a small business loan?
Several factors are considered by lenders when deciding whether to lend to you. The exact criteria will vary from lender to lender, but some things to note are:
Age of business: Some lenders have a minimum period that the business needs to have been operating for before they agree to lend. This is because established businesses are less of a risk for them to loan to.
Turnover: You may have to prove a minimum turnover to be eligible for a loan. But the amount and whether it’s calculated monthly or annually varies from lender to lender.
Business financials: Lenders will request other financial information including details of existing bank accounts and loans, profit statements, tax returns and financial projections.
Credit profile: Your business’s credit history will be taken into account as well as the credit profiles of all directors involved in the business.
Biz Loan Comparison allows you to compare small business loans to make sure you’re getting a great-value loan that delivers as it should.
Still have questions? Let’s talk
Confused? Not sure if this applies to your situation? Phone us on 1300 190 429 for some free, no obligation advice.
Or want to compare business loans now?
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