The decision to take out a business loan is a big one! If you think an infusion of outside funds could help you expand or save money, here are 10 questions to ask yourself.
1. Do I really need a business loan?
Taking on debt of any type can be risky. You don’t want a loan to cut into your cash flow, making it difficult to meet your monthly obligations. Explore why you need funding and how it can help you reach your goals. Common reasons entrepreneurs seek out business loans include:
- Needing working capital
- Refinancing existing high interest business debt
- Building good credit for the future
- Purchasing equipment
- Purchasing inventory
- Increasing marketing
- Taking advantage of a sudden business opportunity
If you run a profitable business with decent cash flow but need funds to expand or refinance expensive debt, a loan can be a good idea.
2. How much do I need to borrow?
Your annual gross sales, existing debt, and creditworthiness determine how much a lender will loan to a small business. But first, you need to come up with a number. How much money do you need to meet your business goals? A good place to start is by writing or updating your business plan. An effective business plan can help you manage money and indicate how much of an infusion would be the most helpful to your business.
If you don’t have a business plan, the SmartBiz Small Business Blog has an article to help you get started: How to Write a Business Plan for Your Small Business (Without Going to Business School).
3. What kind of loan is best for my needs?
The lending world has expanded far beyond term loans from a bank. There are now lots of options from a host of different lenders. In addition to traditional bank term loans, other types to consider include SBA loans, lines of credit, invoice financing, merchant cash advances, and even a business credit card.
4. How quickly do I need funds?
Do you need to jump on a business opportunity or is your loan timeline flexible? Funds from some loans can be available in as little as a day while other loan applications can take weeks or even months. Keep in mind that fast money is usually expensive money.
5. What other debt do I have?
Do you know your debt service coverage ratio(DSCR)? The DSCR helps lenders determine whether a business can take on a loan. The calculation is based on your available cash flow when compared to current debt and is one of the key metrics used to assess your eligibility for small business financing.
For help calculating this important ratio, head over to the SmartBiz Small Business Blog and read Standard Business Loan Debt Service Coverage Ratio.
6. What is the true cost of the loan?
If you don’t read the fine print, it can be difficult to determine if the stated interest rate actually reflects the true cost of the loan. Business owners can end up paying much more than they realized and get stuck in a loan they can’t afford to pay.
According to Leo Jacobo, VP, Head of Lending Operations for SmartBiz Loans, there is a relatively easy way for borrowers to discover the actual loan cost. That way is to determine the loan constant. Leo writes, “The loan constant is one of the oldest concepts in lending and used regularly by banks to calculate debt service burdens for both consumers and businesses. The loan constant reflects the full amount of cash required annually for debt service.”
Compare “apples to apples” by factoring the loan constant when considering different types of loans. Multiply your monthly payment by 12, and then divide the figure over the original loan balance. The resulting percentage is the true cost of borrowing as it reflects the total payment, interest as well as amortization for loans that require principal pay down.
Review this article for more information and specific examples: What Small Business Owners Need to Know About the Loan Constant.
7. Is there a prepayment penalty?
If your strategy is to get a loan and pay it off quickly to save on interest, you might be out of luck. Read the fine print and talk to your lender to discover if you’ll pay penalties – and how much those penalties will be – for an early payoff. An early payoff can cost you more in the long run.
Note: 10 year term SBA 7(a) loans facilitated by SmartBiz Loans do not have a prepayment penalty. You can pay off your loan any time without an additional cost.
8. Do I qualify for an SBA loan?
SBA loans are known as the “gold standard” in small business loans because of low rates, long terms, and very low monthly payments. Before you explore other types of financing, see if you’re qualified for an SBA loan. These are the eligibility requirements to apply for a $30,000 to $350,000 SBA 7(a) Working Capital or Debt Refinance Loan from banks that participate in the SmartBiz marketplace:
- Time in business must be above 2 years
- Business owner’s personal credit score must be above 650
- The business must be U.S. based and owned by U.S. citizen or Lawful Permanent Resident who is at least 21 years old
- No outstanding tax liens
- No bankruptcies or foreclosures in the past 3 years
- No recent charge-offs or settlements
- Current on government-related loans
*SmartBiz Loans conducts a soft credit pull that will not affect your credit score. However, in processing your loan application, the lenders with whom we work will request your full credit report from one or more consumer reporting agencies, which is considered a hard credit pull and happens after your application is in the funding process and matched with a lender who is likely to fund your loan.