Understanding Small Business Loans
Small business loans are normally used to start a business, grow a business, purchase inventory or equipment, and acquire real estate. According to research done by the National Small Business Association, an astounding 69% of small business owners used this option to finance their ventures in 2016. Small loans in terms use of credit cards, venture capital and the very popular option of crowdfunding. The remaining 31% were not able to access enough financing.
The NSBA reports clearly identifies the relationship between small business financing and the capacity to hire and retain employees. The ripple effect results in the economic growth of locals and the national economic growth.
Alternative lenders market is ever on the rise, according to a data from U.S. Small Business Administration almost $600 billion was made available to borrowers in 2015 by banks while alternative lenders financed approximately $593 billion in the same year.
While small business loans can be a bit difficult to obtain, there are options out there you can easily use to your advantage. As stated, it is important to understand the cost of borrowing. Let’s get you started.
Business Loan Interest Rates and How They Work
There are three commonly known SBA loans: SBA, 7A loans and SBA Express loans. They are ideally used for a broad range of purposes like refinancing and capital growth and CDC/504 loans are commonly used for the purchase of fixed assets such as real estate and machinery.
- SBA – Small Business Administration sets the limit on interest rates that bank loans can be charged, currently standing at 7.25%-9.75% range for 7A loans, depending on the loan amount and the loan duration. The interest charged is also dependent on the market interest rates, as the market rates change so do rates on these loans
- SBA 7(A) loan terms
These loans do not have a minimum loan amount but have an upper limit of $5 million. In 2015, the average SBA loan amount borrowed was $374000. SBA warranties 85% of the loan if the loan is less than $150000 and 75% for loans above that. The cut-off mark is at $3.75 million. For instance, a loan of $25000 or less paid in under 7 years will be charged at a rate of 8.75%. However, interest rate is not the only factor in some of the expenses. The true cost of borrowing is well captured in the APR which includes fees associated with the loan. Furthermore, these loans have a guarantee fee. In simple terms, while SBA guarantees that the loan will be repaid, they do not do that freely – they charge for this service. Guarantee fees are based on the portion of the loan amount guaranteed, and the duration of the loan.
- CDC/504 loans and loan terms
As stated earlier these type of loans are normally used for the purchase of fixed assets such as buildings, land, and machinery. They are to a degree funded by approved development companies, and not-for-profit organizations with a focus on community development. These loans require the borrower to base a collateral on the loan, in most instances the collateral is the asset or assets being financed and personal guarantees are needed.These loans are issued in 10 and 20-year terms. As of August 2017, the 10-year term loans had an interest rate of 4.49% while the 20-year duration loans were charged at an interest of 4.53 %. The fee percentages do not change but are reset every 5 years based on the principal amount. This is advantageous to the borrower as the amount repaid decreases.
The minimum you can access in this category is $50000 and the maximum is $5.5 million. If you consider taking out a 504 loan, you will be required to pay at least 10% of the cost of the asset. Banks put this requirement at 50% of the loan, certified development companies usually ask for 40%. SBA guarantees 100% of the CDC share of the loan. The loan terms include
- The Treasury bond rate: 10-year duration loans fall under the 5-year treasury bond while the 20 year period loans fall under the 10-year treasury bond
- A guaranty fee usually paid to SBA.
- A servicing fee that goes to the CDC.
- Central servicing agent fee
Upon getting this loan you will be charged all three fees and the Treasury bond rate. You will also be asked to pay a one-time fee of 2.1% to SBA. Thus, your final annual percentage rate will be slightly higher.
SBA loans can be a tad complicated and tedious to apply for, but they provide the best interest rates. If you are in need of financing there are many lenders online willing to help. Do your research, find a financial institution that will serve your needs best.
What Determines Loan Rates?
Lenders look at a few factors such as:
- Market Prime Rate – The rate commercial banks are charging their most credible clients.
- Personal Credit Score – your credit score will greatly impact the loan interest rate you will be charged. Borrowers with a score of 700 and above usually enjoy lower rates. Those with a score lower are charged more as lenders are looking to protect themselves against risky investments.
- How Long You’ve Been in Business – businesses that have been running for two years or less are usually considered risky investments, there is no record to prove the credibility of the business. Thus, borrowers of businesses in this bracket are charged a higher rate than those that have been in business for a longer time.
- Your Business’s Financials – how are your annual revenues, how is the business doing financially, what is the current business debt. Lenders highly consider business profitability, debt on the business and revenue. Some lenders put a cap on the minimum the business has to be earning before issuing their loans. More profitable businesses with approved minimum revenues are charged lower interest rates.
- Loan Repayment Term Length – Short-term loans have high APRs, you will, however, pay fewer interest rates in the long run. Long-term loans, on the other hand, have low APRs but are charged higher interest rates.
- Accessibility of the Loan – Quick business loans that are easily available and easy to apply for come at a significantly higher interest rate as lenders secure themselves from losses as these loans do not require the borrower to base a collateral on the loan. Bank loans, on the other hand, are not easy to fund, tedious to apply for, have strict guidelines and require collateral.
- Business Credit Score – Your business commercial credit score based on trade lines and debt repayment trends on credit cards and any other debt that has been accrued greatly influence the business loan rate fronted.
- Your Business’s Industry – How risky or volatile is the industry the business is operating in? This factors when lenders determine what rates to charge. For example, the hotel and restaurant owners find a tough time getting favorable loans due to the high turnover and failure rate in the restaurant industry. The same applies to apparel businesses, law firms and healthcare businesses. The more volatile the industry, the higher the interest rate charged.
You now have some idea what determines business loan and their interest rates, where you can get them, and how they work. Do not stress over funding anymore. Get online and do your research find a lender who best suits your needs. Fill an application form today!