Types Of Business Loans: Your Guide To The Perfect Pick

Choosing the right business loan can often mean the difference between success or failure. Several loan types are available from various financial institutions and online lenders, and each has unique benefits. However, not every loan type will fit a particular business owner's unique economic situation. Without a prior understanding of what you’ll need, it’s possible to pick a loan that does more harm than good. Our guide can help you find the right fit. Here are the types of business loans most popular for funding a small business.

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1. SBA loans

The most common misunderstanding about Small Business Administration loans is that the SBA lends money directly to small businesses – it doesn’t. Instead, the agency provides a guarantee on the loan, promising to reimburse the bank for a certain percentage of the loan if there is a default. This guarantee lowers the risks to lenders, encouraging them to offer these loans to more American small businesses.

Here are the available types of SBA loans. Note that each has different requirements to qualify, and the approved uses of proceeds varies.

The 7(a) Loan Program

Purposes

An SBA 7(a) loan is a flexible option for established businesses. The Small Business Administration backs these loans to minimize a bank’s risk in lending to you. While the SBA doesn’t directly provide money to borrowers, its backing can make it easier for you to qualify for a loan. When banks can lend with less risk, they can generally approve more borrowers. Funds can be used for a variety of business-building initiatives including:

  • Working Capital Purchase equipment, increase inventory, add marketing programs, add staff or use for day-to-day operating expenses.
  • Debt Consolidation Loans Refinance merchant cash advances, short-term business loans, high interest business loans, daily or weekly payment loans or business credit cards.
  • Commercial Real Estate Refinance an existing commercial real estate mortgage or buy an office building or other owner-occupied commercial space.

Advantages:

You might have heard that SBA loans are the best option for small business owners who want to expand. It’s true. SBA loans have low interest rates and long terms, meaning monthly payments are very low.

Disadvantages:

If you have an immediate need for funds to jump on a business opportunity, you might need a faster option. Because SBA loans are guaranteed by the government, more paperwork may be required than for other loan options.

How to qualify:

Each lender will have slightly different requirements, so check with the bank to determine specifics. Here are some general qualifications for an SBA 7(a) loan through the SmartBiz Loans® trusted bank network:

  • 2+ years in business
  • Business owners must be U.S. citizens or legal permanent residents
  • The business owner’s personal credit score must be above 675
  • Business and personal cash flow to service all debt payments demonstrated by tax returns and interim financial data
  • No bankruptcies or foreclosures in the last 3 years
  • No outstanding tax liens
  • No delinquencies and/or defaults on government loans

SmartBiz offers a streamlined application process that matches you with the bank most likely to fund your particular business. In fact, about 90% of the applications referred to our trusted bank network are approved. Learn why small business owners across the U.S. rave about our process and people on TrustPilot®.

The 504 Loan Program

The SBA’s 504 Loan or Certified Development Company program is designed to provide financing for the purchase of fixed assets, which usually means real estate, buildings and machinery, at below-market interest rates. Typically, up to 50% of project costs are funded by a lender backed by the SBA. CDCs (Community Development Corporations) usually fund up to 40% of the project cost. The final 10% is a cash down payment expected to come from the small business owner.

Purposes:

This program was created to give small businesses low-cost funds for expansion or modernization.

Advantages:

A 504 SBA loan might be a good fit for small business owners interested in purchasing a commercial real estate property if their unique business circumstances fit with the public policy goals of the local CDC.

Disadvantages:

The 10% cash down payment might be a deterrent for some business owners. Under certain circumstances, for startups and special-purpose properties, you may be required to contribute up to 20 percent of the total project cost. Additionally, loans are generally capped at $5 million.

How to qualify:

To be eligible for a 504 Loan, your business must be operated for profit and fall within the size standards set by the SBA. A business qualifies if it has a tangible net worth not more than $15 million, and an average net income of $5 million or less after federal income taxes for the preceding two years prior to application. Loans cannot be made to businesses engaged in nonprofit, passive or speculative activities. For additional information on eligibility criteria and loan application requirements, small business and lenders are encouraged to contact a Certified Development Company in their area.

The Microloan Program

The Microloan Program is for very small businesses, including start-ups, and provides loans of up to $50,000.

Purposes:

Proceeds from an SBA Microloan can be used for most business expenses to launch or grow a new business.

Advantages:

There aren’t a lot of low-priced startup loans available, so the program is a great fit for new entrepreneurs.

Disadvantages:

Proceeds from an SBA Microloan cannot be used for paying down debt or real estate purchases. Also, it can take an average of four weeks or more to fund since applications must be approved by both an intermediary lender and the SBA. Patience is key.

How to qualify:

Requirements to qualify for a microloan can vary depending on the lender. However, compared to SBA loans with higher loan amounts, the requirements for eligibility are more relaxed to cater to startups. Additionally, some small business experts say that microloans are a great starting point for women or minority business owners seeking funding.

2. Bank term loans

With a bank term loan, you borrow a set amount of money upfront and pay back with interest, on a specific repayment schedule. The following bank term loans are available through banks in the SmartBiz network for working capital, debt refinance and new equipment purchase:

  • $30,000 to $500,000 loan amounts
  • 2 – 5 year repayment terms
  • Monthly repayments
  • No prepayment penalties

*Interest rate depends on loan term and the applicant's credit and financial profile.

Purposes:

Bank term loans are good for business owners who have a specific need for funds – like inventory or equipment – or who have an ongoing need for working capital.

Advantages:

Term loans can be a great fit if you need fast funding. Paperwork requirements are often less than with other types of loans.

Disadvantages:

Rates are usually not as favorable as SBA loans. Additionally, the short terms make payments larger, cutting into cash flow.

How to qualify:

SmartBiz Loans offers Bank Term loans through our online, streamlined technology platform. Uploading documentation is fast and easy – no faxing or copying required. Here are some of the basic qualifications:

  • 2+ years in business
  • No bankruptcies or foreclosures in the last 3 years
  • Business owners must be U.S. citizens or legal permanent residents
  • No outstanding tax liens
  • Business owners must have personal credit scores above 640
  • Business must have cash flow to support loan payments

Create an account at SmartBiz Loans today and discover if you’re prequalified in 5 minutes or less with no impact on your credit score.*

3. Business lines of credit

If you’re looking for a flexible financing option when you’re in a pinch, a business line of credit might be a good fit for you. This type of loan works like a credit card, where you only pay interest on the amount that you withdraw.

Purposes:

This option is known for its flexibility because it allows borrowers to take out the amounts they need at any time, with interest charged only on individual withdrawals. If you’re looking for a flexible financing option when you’re in a pinch, a business line of credit might be a good fit.

Advantages:

Small businesses can use lines of credit to fund recurring operating expenses, shore up cash flow while waiting for customer payments, cover seasonal shortages, pay for unexpected emergencies, and more.

Disadvantages:

If you have a low credit score, your rates will probably be unfavorable, making this an expensive option.

How to apply:

A good first step is to contact the bank you have an existing relationship with. To qualify for a line of credit, most traditional banks often require at least two years of business history and healthy annual revenue.

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4. Equipment financing

You can use regular business loans to purchase equipment, but a dedicated equipment financing loan uses the equipment you buy as collateral. This lowers the average APR rates and makes the loan open to businesses with poor credit ratings. Loan amounts depend on the value of the equipment, up to 100% of the cost of the item, and funding usually takes a couple of days to come through. Loan terms can be as long as the equipment is still usable but are typically around 5 years.

Purposes:

To purchase equipment needed to run your business. Equipment can range from computers to vehicles.

Advantages:

Equipment financing is available to new as well as established businesses. Business owners with low credit scores are typically able to qualify. You can use your equipment even while you are paying off the loan.

Disadvantages:

Time to fund can be lengthy and rates are usually not as good as with other business loans.

How to apply:

Some typical paperwork required to apply includes the equipment invoice, bank statements, and tax returns. Banks and online lenders offer equipment loans and will have varying requirements.

5. Merchant cash advance

A merchant cash advance is not a loan in the traditional sense. If you take out an MCA, a financing company advances cash to you in a lump sum. They then take a percentage of your daily credit card and debit card sales, on top of charging a fee. An example from Wikipedia® outlines a sample transaction:

A business sells $25,000 of a portion of its future credit card sales for an immediate $20,000 lump sum payment from a finance company. The finance company then collects its portion (generally 15-35%) from every credit card and/or debit card sale until the entire $25,000 is collected.

Purposes:

Cash from an MCA can be used for a variety of purposes. Business owners who might not qualify for a typical business loan can get approved.

Advantages:

Applications for an MCA are typically online and you can get approved the same day you apply.

Disadvantages:

Buyer beware. The old adage applies here: fast cash is expensive cash.

How to apply:

Getting an MCA can be easier than other types of funding to apply for with a fast online process. MCA companies review your credit card processing statements to determine if you have enough business volume. Some MCA companies ask for credit scores and bank statements, as well. Others don’t require this.

6. Invoice factoring

Business owners use their outstanding invoices to get a cash advance from a lender. With invoice financing, a lender advances you a percentage of your total invoice amount, usually around 85% to 90%, and holds onto the remaining percent.

Purposes:

You can use the advance to cover business expenses while you’re both waiting for your customer to pay. During that time, the lender will charge a weekly fee. Once your customer pays, the lender will return the remaining 10% to 15% minus the fee.

Advantages:

Invoice factoring can help if your cash flow problems stem from customers who pay at different times. The advance can be used to cover payroll, rent, and other fixed operating expenses.

Disadvantages:

With invoice factoring, you’re handing complete control of your invoices over to another company. Some business owners don’t like another company having access to their financial information.

How to apply:

Research invoice factoring companies and consider the type of service you need.

Which loan is right for you?

Not every loan can meet the financial needs of every business owner, so it’s important to consider your personal financial situation before applying. There are several key factors to consider before choosing a loan option, such as the following.

  • Credit score. Your credit score measures how reliably you’ve repaid your previous loans. Most traditional lenders only cater to borrowers with scores above a certain amount because it tells them that repayment is likely. Some alternative online lenders also require minimum credit ratings, but others may only require basic personal information.
  • Time in business. The longer your business has been open, the more evidence it can show that it will turn a profit with the loan. To banks, that means you’re more likely to repay your loan. As such, SBA loans and traditional banks usually require at least two years of time in business.
  • How fast you need funding. While traditional loans provide higher-value loan plans, they often come with eligibility criteria that not everyone can meet. These added prerequisites often lead to longer application processing, which means you could wait several months for your capital. By comparison, alternative online loans have fewer eligibility requirements and faster processing times. Sometimes, payout can happen on the same day.
  • Interest rates. Traditional and alternative loan interest rates vary among lenders but follow certain trends. Generally, traditional loans have lower interest rates and monthly payments, while the latter is higher on both fronts. Additionally, lower interest rates tend to come paired with higher loan amounts and vice versa. Choosing one over the other is a matter of how long you want to be in repayment and how much you can pay per month.
  • Repayment terms. Long-term bank loans can have repayment periods of around two to five years. SBA loan terms range from 6 to 25 years, while short-term alternatives can have terms of 6 to 18 months. A longer term means lower monthly payments and often comes with lower interest rates. On the other hand, short-term loans have higher monthly payments and interest rates, but you get the money more quickly.

Adding it all up

There are lots of business loans out there and the right one for your business depends on several factors. Look at your personal and business credit scores, business finances, time in business, and how you want to use the funds.

Once you’ve determined your needs, visit SmartBiz. When you create a SmartBiz account, you’ll be assigned to a team of dedicated professionals who will stay with you every step of the way. We get to know you and your business and make sure you understand your financing options whether that’s an SBA loan, Bank Term loan or something else. We then match you with the bank most likely to approve your application.

See if you pre-qualify here today and get ready to fund your business dreams.

*We conduct 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.

WHAT YOU NEED TO KNOW: The SmartBiz® Small Business Blog and other related communications from SmartBiz Loans® are intended to provide general information on relevant topics for managing small businesses. Be aware that this is not a comprehensive analysis of the subject matter covered and is not intended to provide specific recommendations to you or your business with respect to the matters addressed. Please consult legal and financial processionals for further information.

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