There are many different types of loan products that are available for small businesses, which can make small business financing confusing for business owners. Among the various products, a short-term business loan is one of the easiest financing options to understand. Term loans can provide working capital to businesses so that they can use the funds to make large purchases. Since these loans feature regularly scheduled payments, they also allow business owners to budget more effectively. The following is a simple guide to term loans to help you understand how you can use a loan to fuel your business’s growth.
What is a business term loan?
Term loans are loans from banks or alternative lenders for a specified amount. These loans have repayment schedules featuring regular repayments with either a floating or fixed interest rate. When businesses are approved for term loans, they will be provided with lump sums of money upfront. They will then repay the loan balances at regular intervals over the life or term of the loan. They are called term loans to refer to the length of the period of repayment.
A term loans may be a smart choice for businesses that are established and have sound financials. Business term loans have several characteristics that differentiate them from other available business financing options. They typically feature lower rates of interest than other types of credit such as business credit cards or lines of credit. They are more flexible in their uses, and they offer predictable repayment schedules. Because term loan proceeds are provided in a lump sum, businesses typically use them to invest in growth.
There are three primary types of term loans, which depend on the term or length of the loan. Short-term business loans are normally available to businesses that may not qualify for lines of credit. In general, short-term loans have terms of one year or less.
Intermediate-term business loans have terms of more than one year up to three years. Companies repay these loans in monthly installments from their cash flow. Long-term business loans have terms of three years up to 25 years. These loans require companies to offer some assets as collateral. They may require payments to be made at quarterly or monthly intervals from the business’s cash flow or profits. Long-term loans limit the financial commitments that the company can assume, including principals’ salaries, other debts, or dividends. They might also require the business to set aside a portion of their profits to repay the loans.
What are the pros and cons of short-term loans?
There are both pros and cons of short-term business loans. Understanding them helps business owners determine whether this type of term loan might be right for their companies.
Short-term loans have fast application processes and approvals. Businesses are required to complete minimal paperwork during the loan application process. They also have lower interest rates than business credit cards. Short-term loans often feature high rates of approval, and they can be used by businesses for any type of business expense. They also offer flexibility in repayment terms, and the lenders may offer several repayment terms from which to choose. Businesses and business owners with poor credit may also have an easier time being approved for short-term business loans than for other types of business financing. In most cases, bad credit scores are acceptable.
Short-term loans also have a couple of disadvantages. The interest rates that are charged are higher than the rates that are charged for traditional bank loans or Small Business Administration (SBA) loans. The loan terms are shorter than SBA loans and typically range from six months to two years.
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Is collateral needed to secure a term loan?
Short-term business loans from most alternative lenders do not require any collateral. By contrast, long-term business loans will generally require businesses to secure loans using some of their assets. Since the terms for short-term loans are relatively short, most alternative lenders do not require companies to offer assets for collateral.
What are the top use-cases for a short-term business loan?
Businesses can use funds from short-term business loans in several ways. Here are the most common use-cases for term loans.
1. Real estate purchases and expansion of operations
Growing businesses must move quickly when they find the right piece of real estate. A business might find a larger office space that is needed for a growing team, or a second location for an expanding company. A small business term loan can quickly provide a larger amount of working capital to help a business to grow and expand.
2. Purchases of inventory and supplies
Businesses may also benefit from short-term loans by purchasing inventory and supplies when they are needed. Having the ability to pay invoices for supplies and inventory quickly helps businesses build goodwill with their suppliers and vendors.
3. Finance equipment purchases
Businesses rely on their equipment to continue operating. When business equipment fails, it can be expensive to replace. Business term loans allow a business to replace or repair equipment at the time that it is needed. Since the approvals are fast, these loans can help reduce any downtime in a business’s operations.
Depending on the type of business, a company might also need to purchase heavy equipment or vehicles. These types of purchases can be expensive but unavoidable for certain businesses. Term loans can make vehicle and heavy equipment purchases possible for small businesses. As long as the length of the term loan matches or is less than the vehicle’s useful life, it can make sense to finance vehicles in this way.
4. Refinance/pay off existing debt
Businesses that have multiple business loans and credit cards that have different interest rates can benefit from refinancing them into one loan. This can help businesses to streamline their monthly payments and simplify cash flow management. Businesses might also secure lower interest rates on term loans than the rates that they were paying for multiple loans and credit cards. By refinancing and paying off all of the existing debts with a term loan, a business can enjoy additional cash flow from savings on interest costs.
5. Get working capital to manage day-to-day business expenses
Businesses sometimes experience ebbs and flows because of regular business cycles. During leaner times, short-term business loans can provide businesses with the working capital that they need to make it through until more profitable times. This can help a business continue operating smoothly even when times are tight.
How to apply for a business loan
Applying for a business loan will require some preparation. First, you will need to check both your business and personal credit scores. You should then figure out how much money you need to borrow. Then, get your documents ready. You will need three months of recent bank statements. You can then research different loan offers online and apply for the loan that offers the best rates and terms.
What are the qualification requirements for a short-term loan?
Lenders that offer short-term business loans have a few qualification requirements, including the following:
- Length of time in business
- Monthly revenues
- Credit score
Lenders prefer that businesses have been established for a minimum of three to six months, and that they have monthly revenues of $10,000 or more. Lastly, lenders prefer that the businesses have credit scores of at least 550.
Business term loans may be used by companies for a variety of purposes. These loans are fairly straightforward and feature quick applications and approvals. Business owners can benefit from having predictable payments over the life of the term loans, which can help them to plan and budget more effectively. When businesses need capital, a term loan might be a good option. Business owners can determine how much they need and conduct research on term loans that are offered online before applying.