May 19, 2021
Small Business Loan Terms: What Affects Them?
The bank or working capital lender will want to make money on the deal and lose as little as possible. Ultimately, their return on your loan depends on you repaying the loan on-time, in addition to potential interest and fees.
If a bank or alternative lender is doubtful that you’ll pay back your loan responsibly, they may charge more in interest and fees. Thus, it’s a give and take between risk and return – if you’re seen as a risky borrower, you’ll see less satisfactory terms because the financier must justify taking a risk.
Because of these factors, and others, you should take time to consider your loan amount and term prior to committing. If you don't thoroughly examine your financing options, you may put yourself in stressful position in which you can't make your monthly payments on-time.
If you can't repay your loan responsibly, it may affect your business's cash flow and other important aspects of your business.
In this blog post, we’ll explain the factors that affect business loan term options so that you can select a loan term that is a good fit for your company.
5 Factors That Can Affect Business Loan Terms
1. Business and Personal Credit Scores
The main principles of business loans don’t differ much from consumer loans like mortgages or student loans. You can expect a thorough credit check by almost any potential business lender. A poor credit score could increase your interest rates and fees on a business loan the same way it would on a mortgage. In addition, don’t make the mistake of thinking lenders won’t care about your personal credit history. In most cases, your personal credit score will have just as big of an impact on your loan terms as your business credit score.2. Your Business Plan
Fortunately for business owners without stellar credit, loan terms won’t solely rely on your credit history, especially if you apply for a loan through an alternative lender instead of a bank. Remember, lenders want to provide your business with financing, but only if you’re worth the risk. To put their mind at ease, submit a professional and comprehensive business plan. Although it won’t drive your loan costs down by itself, a professional business plan helps lenders understand the business they’re investing in. Therefore, the more that they understand your business, the more favorably they’ll look at you as an applicant. Are you a small business owner seeking additional financing? Click the link below for a free financing quote:
3. Business History
The failure rate of new businesses has been well-documented, and business lenders are aware of this. This research can make it difficult for emerging businesses to attain financing, with many banks preferring loan applicants be in business for a minimum of three years. Understandably, many businesses will require additional financing prior to the three-year mark, which is why it can make more sense to work with an alternative lender. Typically, they are less stringent about their time-in-business requirements, only requiring a business be operational for a few months. Regardless, it is important to remember that the length of time that your business has been up-and-running can affect your loan terms. If you’re a new business owner, you can expect a healthy dose of skepticism from potential lenders, especially if they are banks. If you receive a bank loan, you’re likely to pay a higher interest rate or have a shorter payback period than a similar business with a longer track record.4. The Size of Your Down Payment
How would you feel if you boarded a commercial airplane and the pilot already had a parachute on? Most likely, you wouldn't feel very safe if that was the case and would second guess the safety of the flight. Essentially, that’s sort of how it works with business loan terms. When the lender knows that you’re committed to your business, they’ll be more likely to provide you with better terms. Unfortunately, showing the lender that you’re dedicated to your business doesn’t come cheap. A large down payment or significant personal equity in your business might be needed to show lenders that you’ll repay your loan. If you can’t afford to put up collateral, a bank could charge you extra interest and fees, or make your repayment period very short.5. Type of Business
Certain types of business are riskier than others, and lenders know this. Even with a bog down payment and excellent credit, you could face a higher interest rate than a business in a more lucrative industry. Consider the difference between starting a business that provides services to seniors – a booming industry – and starting a video rental business (a dying breed). Again, it boils down to risk and return; chances are, with the number of people aged 65 and older “expected to nearly triple to 1.5 billion by 2050,” a business servicing senior citizens will receive a loan with better terms than a video rental business will.Conclusion: Consider Your Term Loan Options Before Applying
Clearly, business loan terms depend on a variety of factors, both in and out of your control. It’s tough to get a conventional business loan with a low interest rate without a long and successful track record. Still, you should stay diligent, because if you can improve certain areas of your business that are mentioned in this blog post, you’ll hopefully be able to receive a loan with favorable terms.
Editor’s Note: This post was updated for accuracy and comprehensiveness in May 2021.