What are the terms I need to know to compare different small business loans?
Learning the terminology around loans can be confusing at first. Yet, when it boils right down to it, there are only a few really important terms you need to know in order to sift through the mountain of small business loans available. Those terms are as follows:
APR and Interest Rate
APR stands for “annual percentage rate”. It sounds fancy, but it’s basically just the total cost of borrowing money.
You might also see the term interest rate being thrown around. This is simply a multiplier that the lender uses to tack on a finance charge each month. However, the interest rate doesn’t tell the full story when it comes to the cost of the loan. Often, lenders will add on other fees when you take out a loan, such as loan origination fees. These extra fees increase the cost of borrowing money.
In a nutshell, the APR takes into account both the interest rate and the fees to give you one single number. Different lenders charge different interest rates and fees, and this is why a loan’s APR is the best way to compare the cost of different small business loan offers.
How APR Affects a Small Business Loan
Generally, you’ll want to pick a business loan with the lowest APR possible. Let’s look at two hypothetical loans – for the same amount and the same term length, but with different APRs.
|
Loan 1 |
Loan 2 |
| Loan amount |
$10,000 |
$10,000 |
| Term length |
Three years |
Three years |
| APR |
5.00% |
10.00% |
| Monthly payment |
$299.71 |
$322.67 |
| Total interest paid |
$789.52 |
$1,616.19 |
In this case, the difference between 5% APR vs. 10% APR means that you’ll save an extra $22.96 each month with the cheaper loan. By the time you’ve paid off the full loan, however, you will have saved a whopping $826.67! What would you do if you had an extra $827 to spend on your small business?
Term Length
“Term length” simply refers to how long your small business loan will last before it’s fully paid off. Generally, it’s better to pick a shorter term length for two reasons.
First, your business will be out of debt sooner. After all, you don’t want your business saddled with debt 30 years down the line. Second, a shorter term length means you’ll pay less in interest costs overall since you won’t be paying interest for as long.
Different Term Lengths on Small Business Loans
To see how this works, consider the two business loans below. They’re identical in every way, except for the fact that one has a term length that’s twice as long as the other:
|
Loan 1 |
Loan 2 |
| Loan amount |
$10,000 |
$10,000 |
| Term length |
Three years |
Six years |
| APR |
5.00% |
5.00% |
| Monthly payment |
$299.71 |
$161.05 |
| Total interest paid |
$789.52 |
$1,595.55 |
In the example above, you’d save $806.03 in interest charges over the life of the loan by picking the three-year repayment option. You’d also be out of debt three years sooner.
However, you also have to balance out what your business can realistically afford to pay back each month. Saving $800 and getting out of debt three years sooner sounds like a great plan, however, this also means you will need to pay $138.66 more each month to meet that goal.
It’s a tricky balancing act, and the right answer will depend on your company’s needs and cash flow situation.
Collateral
Many lenders will require you to put up “collateral” as a condition for getting your small business loan. Collateral is simply property — such as your company car, real estate, and office equipment — that you agree to hand over to the lender if your business defaults on the loan.
It’s a way to make the loan less risky for the lender because at least they’re guaranteed to get at something back in return for lending out the money.
How do you apply for a small business loan?
Once you understand the nut and bolts of loan terminology, it’s time to apply for a small business loan.
Each lender sets its own requirements for approving your loan. But in general, there are a few documents that a lender will require:
- A business plan. This document details the nitty-gritty of all the different aspects of your business, such as what you sell, how much your products and services cost, and how you plan to market your business.
- A cash flow projection. This tells the bank how much you expect to make — and spend — in the near future.
- A list of capital assets. This tells the bank how much money and other assets are already owned within the business. Your assets could potentially be used as collateral.
- Your personal tax returns and other financial statements. You and any of your business partners will generally need to provide this information to get approved for a small business loan.
It’s a good idea to round up these documents before you get started with the loan application so that the process goes smoothly. The last thing you want to be doing is writing up a detailed business plan on a gorgeous Sunday night right before a presentation is due at the bank early Monday morning.
Finally, make sure that you stay responsive to your lender and are available to answer any questions about your loan application.
What happens when you’re approved for a small business loan?
Congratulations! Small business loans aren’t handed out like candy. Once you receive the money in your bank account, pledge to make every single payment on time, every time.
If you miss a payment or default on the loan then it’s not just your business credit on the line. This can reflect negatively on your own personal credit history as well.
What happens if you’re not approved for a small business loan?
If this happens, check with the lender to see if you can offer up collateral on the loan. This may help tip the scales so that they’ll provide you with small business loan approval.
If not, it’s time to move onto plan B. You may need to apply with a different a lender that has a lower credit score requirement. Or, perhaps you can try asking for less money. Don’t give up and, in the meantime, keep saving your own personal money.
Bottom Line
With a little luck and hard work, you’ll be among the majority of small business owners who have successfully secured financing. After all, 88% of small business loans were approved in Canada in 2015, according to the Innovation, Science, and Economic Development Canada.
Are you ready to apply for a small business loan and grow your business?
