What is considered a traditional loan? And how do they work?

Traditional loans are often the most desirable for small business owners – after all, as their name suggests, they’re a tried-and-true funding option. However, the sheer number of loan options available to potential borrowers can obscure what is considered a traditional loan. Additionally, each type of traditional loan will have specific terms and conditions that give them unique benefits and drawbacks.

This all might make you wonder: How can you know which traditional loan is right for you? And how can you know whether traditional loans fit your needs? Below, you can find additional information about what traditional loans are, and how they might be able to help you grow and strengthen your business.

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What is considered a traditional loan?

A traditional loan is any loan, paid in installments, that a bank offers to small business borrowers. Bank term loans and SBA loans fall under the “traditional loan” umbrella. Below is more information about each of these types of traditional loans.

  • Bank term loans. These loans are any small business funding options that banks offer and that you repay in monthly installments. They are among the most sought-after types of small business financing. You can get them from big-name national banks, local credit unions, and other types of banks. They generally require less paperwork and collateral than SBA loans, and they can be used for a broad set of business needs. Bank term loans have a fixed interest rate and don’t change if the Federal Reserve raises or lowers rates, making them attractive to borrowers who want to budget precisely each month. SmartBiz facilitates bank term loans from banks in our network. Learn more on the SmartBiz website: Bank Term Loans: Great Option When You Need Funds More Quickly
  • SBA loans. These loans are backed by the Small Business Administration (SBA). This government backing mitigates the risk banks take providing these types of loans even if the SBA doesn’t fund them or directly provide them. There are several types of SBA loans, though the three below are the most common.
    • SBA 7(a) loans. Many small business finance experts consider SBA 7(a) loans to be the best traditional loan. Their benefits include long repayment periods of up to 10 years, lower interest rates, and large loan amounts. While there are restrictions for how you can use an SBA 7(a) loan, a small business can use them to fund working capital, debt refinancing, or commercial real estate purchases. SmartBiz facilitates SBA loans through the banks in our network. Learn more on the SmartBiz website: Get great rates, long repayment terms, and low monthly payments with SBA loans.
    • SBA 504 loans. You may qualify for these loans if your funding use aligns with the goals of your local community development corporation (CDC). Often, these loans help borrowers obtain long-term financing to purchase large equipment or real estate. Their benefits are similar to those of SBA 7(a) loans.
    • SBA microloans. These loans are traditionally available to new or very small businesses. Their loan amounts are at most $50,000, which you can use for working capital, fixtures, furniture, inventory, supplies, machinery, or equipment. They’re one of very few government-backed long-term business loans for those who may have issues with their credit.

Key facts about traditional loans

Each of the traditional loans listed above has specific characteristics that differentiate them from other financial options, which can vary slightly between loan types and lenders, but almost always have the following:

Variable or fixed interest rates

Traditional loans will have either variable or fixed interest rates. For example, SBA 7(a) loans have variable interest rates, whereas bank term loans have fixed interest rates.

Variable interest rates, as their name suggests, change over the loan’s term according to the prime rate set by the Federal Reserve. This rate fluctuates based on the economy, though in many cases, variable rates mean less expensive loans in the long run.

Fixed interest rates, such as those for bank term loans, don’t change during a loan's lifespan. In practice, the only way to change a fixed interest rate is to refinance the loan through a different lender. While loans with fixed interest rates often start with higher rates, your monthly payment will be unaffected by changes in the economy, leading to better budget predictability.

Lower interest rates

Traditional loan interest rates are typically lower than other funding options. SBA loans, for example, have lower interest rates and more borrower-friendly terms because the government guarantees a significant part of them. That reduces the lender’s risk, so they don’t have to charge as much for their loans. Non-traditional lenders, such as alternative or online lenders, typically work with riskier borrowers, so they often keep their interest rates high in case a borrower defaults.

Higher loan amounts

Traditional loan amounts are often higher than non-traditional loans. While there’s no one factor underlying this, the most prominent reason has to do with the type of customer doing the borrowing.. Most traditional lenders are highly risk-averse and won’t lend to borrowers with a debt-to-income ratio of greater than 36 percent. This lower-risk lending means these lenders can more safely provide larger loans.

Another reason is traditional lenders often cater to business owners with more expensive financing needs. For example, traditional loans are the go-to for commercial real estate purchases, which are often on the order of millions of dollars. Regular bank term loan amounts range from $30,000 to $500,000 and SBA 7(a) loan amounts range from $30,000 to $5 million.

Longer repayment terms

While the life of a loan can differ depending on several factors, traditional loans often offer longer repayment periods than other options. Typical short-term loans from non-traditional sources often have repayment periods of six to 18 months. Traditional loans instead have loan terms of one to 25 years. Bank term loans are on the shorter end of this range, with payment terms spanning two to five years. SBA 7(a) loans make up the longer end, with terms of either 10 or 25 years.

Often require collateral

Traditional loans often require collateral to minimize the lender’s risk. Collateral is an asset (such as your home or car) that can be seized in the event you can’t make the payments on your loan.  . If you fail to repay your loan, the lender can take and sell the collateral to pay off the rest of the loan’s balance.

Acceptable collateral depends on your loan amount and type. Financial institutions usually accept easily liquidated assets such as stocks, bonds, real estate, company vehicles, and inventory for small business loans. The value of all your collateral assets must be equal to or greater than your loan amount.

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Strict application criteria

Since traditional loans offer high loan amounts with favorable borrowing terms, there is, generally, a pretty high bar to qualify for them. Three of the most important factors that influence a borrower’s eligibility are as follows.

  • Credit score. The higher your credit score, the more likely traditional lenders are to trust you can repay a loan. Most traditional loans require a credit score of at least 680, though SBA microloans are available if your credit score is at least 620.
  • Business experience. Your company must have at least two years in business before you can qualify for SBA 7(a) and 504 loans. That’s because financial institutions view established businesses as far more likely to have enough revenue to repay loans.
  • Business plans. A business plan outlines your long-term financial goals and how you’ll achieve them. It can reassure lenders that you’ll eventually earn enough revenue to repay the loan. Note that SmartBiz does not require a business plan to apply for a loan from a bank in the SmartBiz network.

Longer  application process

As a result of their strict eligibility criteria, traditional loans often come with longer application processes. The application itself can take up to an hour – sometimes more – to complete, depending on how prepared you are with your documents when you start. How long it takes the application to process depends on the lender and the type of loan.  If you work with SmartBiz to secure an SBA loan, once the application is approved, funds can be deposited into your bank account in as few as 7 days.

Who offers traditional loans?

Banks and similar lending institutions typically offer traditional loans. Banks fund term loans and SBA loans, though the government  guarantees part of SBA loans to try to ensure that high-value financing is more accessible to the average applicant, and that lenders can confidently make more loans.

How do traditional loans work?

Applying for traditional loans is often time-consuming, but being prepared can simplify the process. Below is an overview of the necessary steps to complete an application so that you can go in more prepared.

1. You determine your ideal loan amount and find lenders that can provide it

The maximum loan amount that traditional institutions will offer a borrower can differ from lender to lender. To determine which financial institution best meets your needs, consider identifying the exact need you’re trying to fulfill and how much it costs.

2. You gather the required documents

You’ll need several documents to confirm your identity and help lenders determine your eligibility. Some documents you’ll likely need include, but are certainly not limited to:

  • Personal tax returns. These help the lender ascertain whether you’re fiscally responsible.
  • Professional resume. These verify your professional background, which can help banks mitigate any perceived financial risk.
  • Personal background statement. This document provides a snapshot of your background. It includes your criminal record, previous names, previous residences, educational experience, and more.

3. Complete an application

After you determine how much capital you need and which lender may be able to help you attain it, it’s time to complete the application. Filling out the necessary forms can take 15 minutes to an hour. Mistakes can cause the lender to send the application back to you, prolonging this part of the process.

4. If approved, go over terms with your lender

Once your application has been approved, the lender will provide an overview of the exact loan terms, including your loan amount, repayment term, interest rates, and other relevant conditions.

5. Await, obtain, and use your funds

Processing traditional loan funds often takes time. A standard bank loan term can take two to three weeks to fund, while an SBA loan can take up to three months. Once you receive your loan, you can use it for business expenses within the parameters set for the type of loan. For example, SBA 7(a) loans can only be used for working capital, debt refinancing, or commercial real estate purchases.

6. Set up monthly payments

Lastly, you’ll set up your monthly payment schedule. With traditional loans, the longer your repayment period, the less you’ll typically have to pay per month.

Who can get a traditional loan?

Traditional loans are generally for borrowers with an established business or prior business experience, as well as good credit. The SBA works to open traditional loans to small business owners who wouldn’t usually qualify or applicants who want to fund a startup.

Apply for traditional loans with SmartBiz

Traditional loans are valuable funding sources if you qualify. Their higher loan amounts and longer repayment terms can help you affordably achieve your business goals. Although the application process for a traditional loan can be time-consuming, it’s faster with SmartBiz®. Check now whether you pre-qualify* for traditional loans based on your finances.

*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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