August 22, 2024 | Last Updated on: August 30, 2024
Disclaimer: Information in the Business Financing Blog is provided for general information only, does not constitute financial advice, and does not necessarily describe Biz2Credit commercial financing products. In fact, information in the Business Financing Blog often covers financial products that Biz2Credit does not currently offer.
When you’re trying to start or grow a small business, loans can be a major lifeline. Small business loans give qualified businesses access to the money they need to cover the costs of operating and building a business. From the paychecks of a few new employees to major purchases like equipment or real estate, small business loans are great resources for entrepreneurs looking for small business funding. However, loans are not gifts. They always have strings attached, and it’s crucial to understand the terms for repaying business loans.
Failure to repay a loan or meet the loan terms can have severe consequences, including hits to your personal credit score or a lien on your business. The strategies for repaying business loans outlined here can help you avoid penalties and keep your business in good standing to reach its financial goals.
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Generally speaking, business loan terms are similar to any other loan you may have taken out, like a car loan, private student loan, or mortgage. Once approved, you receive a lump-sum payment of the loan amount, then must repay the money you borrowed over time, plus interest and fees. Usually, business loan terms call for monthly payments for a specified period of time, but sometimes you may have to make payments daily, weekly, or in other time increments.
Like personal loans, business loans may be either secured or unsecured. A secured loan is one that requires collateral to back the loan, like property, equipment, cash, or investments. If you fail to repay the loan, the lender may repossess this collateral. An unsecured loan, on the other hand, does not require collateral. Rather, you will most likely have to sign a personal guarantee saying you will repay the debt out of your personal assets if the business fails to repay the loan.
There are many types of business loans, but these are some of the most common:
A term loan is a traditional loan in which a lender gives an approved business a lump sum of money in exchange for business repayment terms. Because they’re so common, terms are highly variable and will often depend on the business owner’s financial profile, the business’s current financial situation, and the amount of money requested.
Different lenders have different limits and requirements, but repayment terms may extend to up to 20 years, loan amounts may go up to several million dollars, and interest rates typically start around 6%. Private lenders tend to have the highest interest rates and fewest protections for businesses. Although you may have flexible repayment options, a standard repayment plan includes monthly payments.
Pros of Term Loans
Cons of Term Loans
SBA loans are partially guaranteed by the American Small Business Administration (SBA), meaning that if a business defaults on the loan, the SBA will pay a portion of the amount owed to the lender. This partial guarantee lowers the risk of the lender not getting any money back, making it more likely to extend a loan to a business it might not otherwise approve. It’s not a subsidized loan, but it can help some businesses get approved.
However, because SBA loans lower the risk for lenders and borrowers alike, they have much more rigid qualification requirements and a slow approval process. The SBA recommends a personal credit score of at least 640 to qualify and the most common loan program, 7(a), may take up to 90 days for approval. (If you have bad credit, you may need a cosigner.)
SBA loans tend to have higher interest rates, but start at a somewhat competitive 11.5% for well-qualified borrowers. Loan amounts typically range from $30,000 to $5 million and have extended repayment terms of up to 25 years.
Pros of SBA Loans
Cons of SBA Loans
A business line of credit, while technically not a loan, is a short-term financing type that gives small business owners a line of credit to draw upon when they need cash. While your business is approved for a maximum amount, you don’t actually pay any interest on that amount unless you draw on the available credit. Even then, as long as you pay back the funds quickly, you can avoid paying interest at all.
Business lines of credit usually have lower limits than loans and are calculated based on your personal and business finances. They have the highest interest rates of common financing types and typically have repayment terms of 3 to 5 years.
Pros of Business Lines of Credit
Cons of Business lines of Credit
Things change, and sometimes projections don’t pan out. While it’s always important to only accept business loan terms that you know you’ll be able to satisfy, it is possible to change your business loan repayment terms.
The best way to adjust how you’re repaying a business loan is to refinance the debt repayment plan. As the Federal Reserve changes rates over time, your business may be able to refinance a loan into a lower interest rate. If your business is struggling to meet a high monthly payment, a lender may be willing to increase the term length to lower the monthly payment.
If you’re concerned your loan may go into forbearance, talk to your loan servicer. They can discuss refinancing options with you, but remember that you’ll pay a fee whenever you refinance. Origination fees or refinancing fees may cost anywhere from 2-5% of the loan amount, so you’ll need to make sure the savings you’ll get from lowering the interest rate or extending the terms are worth the extra cost.
Depending on the loan balance, some lenders may allow you a grace period to make a payment or put a high interest loan into deferment until you have some more financial flexibility.
If you have several loans, building a new consolidation loan may be necessary to pay them all off. Unlike the avalanche method of paying off loans with the highest interest first, a consolidation loan helps you become debt-free by setting up a new loan with a new minimum payment for the life of the loan.
Meeting your business loan terms is vital to keep your small business in good financial standing. These tips can help ensure you don’t fall behind on payments.
One of the simplest things to do to avoid accidentally missing a payment is to set up autopay. Most lenders offer an online portal to view your loan balance and manage your loan. There, you can set up automatic payments to ensure you don’t go into forbearance because you simply forgot to pay.
It’s a good idea for any small business to have a rainy day fund or some cash reserves in case business slows down or there’s an economic downturn. Likewise, after you’ve taken out a loan, setting some extra money aside each month will help you prepare for lean months. Setting up a save plan will help you prepare for tough times.
Every business has an operating budget to pay employees, afford raw materials, pay the office rent, and all the other expenses a business has every month. When you have a debt, it’s crucial to prioritize your monthly loan payment at the top of your budget. When money is tight, make some cuts in other areas before you opt to miss a loan payment.
Every month, your monthly payment should be a top priority in your business’s operating budget. Less essential things like business travel, client lunches, or merchandise should go on the chopping block before missing a payment.
For many businesses, one of the main reasons they got a loan was to invest in growth. Growth comes with additional expenses and it may become more challenging to track spending.
Depending on your budget, it’s crucial to hire an accountant or bookkeeping service to keep up with the company’s financials. Whether it’s a full-time or part-time employee, a contractor, or third-party software or service, having strong bookkeeping will help you understand your business’s cash flow after you’ve used the loan to invest in growth. That way, you’ll better understand your monthly expenses and ensure you always have the money available to repay the loan, or have clarity to readjust your loan repayment terms, if needed. (Not to mention, clear accounting helps avoid misusing loan funds.)
Depending on your business loan terms, you may be able to pay extra each month or make additional payments to pay the loan off early. When your business experiences a windfall or you get a big tax refund, it’s not a bad idea to take some of that surplus revenue and pay down your principal balance. That will save you interest charges in the long term and may even allow you to pay off the loan early.
Of course, the downside is that you won’t be able to reinvest that money in your business or pay it out to investors as profits. A loan calculator can help you figure out how much you may save by making an extra payment here and there.
Running a business is hard, and things don’t always go how you hope. If at any time you think you might miss a payment, let your lender know ahead of time. In addition to extending the repayment period to get the next payment in, a lender may have repayment assistance programs to help businesses struggling to pay back loans. Your lender doesn’t want your loan to go into forbearance or default. They want their money, even if they don’t recoup the total interest over the life of the loan.
Working with the lender, you may be able to put some interest into deferment or develop a repayment strategy that works better for your business. Whether it’s an income-driven repayment plan or an extended repayment term.
Failing to repay a business loan can have serious consequences. Even though all business owners are required to separate personal finances from business ones, personal assets aren’t always protected if you default on a business loan.
If you default on a business loan, you may face these consequences:
Business loans can be a great way to get your business off the ground or help it expand into new markets. However, repaying business loans isn’t always easy, especially if things don’t go as well for your business as you hoped. Nonetheless, you must find ways to meet loan repayment terms or you’ll face serious consequences for both your business and personal assets. These strategies, from setting up tighter bookkeeping to making surplus payments when possible, can help your business avoid defaulting on a loan.
There are many good strategies to help a business repay a loan, but the best are fairly straightforward. Hiring an accountant or bookkeeping service to better track your spending, and always building your loan repayment into your monthly operating budget will help your business stay compliant with the business loan terms.
Some lenders include penalties for early or excess payments in the business loan terms. If that’s not the case, however, small businesses can repay business loans faster by using profits or surplus revenue to pay down the principal balance each month.
Having an accountant or bookkeeping service categorize all of your business’s spending makes it easier to understand where your business may have some room to cut back. If you’re overpaying on non-essential things like business travel, client lunches, or merchandise for employees, these are easy items to cut back on to make sure you repay your debts.
When small businesses go into default on a business loan, they may face a lien on their business or lose the collateral used to secure the loan. Not only will they owe penalty fees, but they’ll have to satisfy the loan terms by handing over collateral like equipment or real estate to the lender, and will not be able to get additional loans or sell their own assets until the debt is repaid. Not only that, but small business owners may see their personal credit score take a hit and have a more difficult time getting a loan in the future.
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