In their book Start Your Own Business, the staff of Entrepreneur Media Inc. guides you thru the critical steps to starting your business, then supports you in surviving the primary three years as a business owner. during this edited excerpt, the authors outline the seven different sorts of loans you’ll get from a bank.
When you are looking for debt financing for your business, there are many sources you’ll address, including banks, commercial lenders, and even your personal credit cards. And you don’t get to pinpoint the precise sort of loan you would like before you approach a lender; they’re going to assist you to decide what sort of financing is best for your needs. However, you ought to have some general idea of the various sorts of loans available so you’ll understand what your lender is offering.
Here’s a glance at how lenders generally structure loans, with common variations.
1. Line-of-credit loans.
The most useful sort of loan for small-business owners is that the line-of-credit loan. In fact, it’s probably the one permanent loan arrangement every business owner should have with their banker since it protects the business from emergencies and stalled income. Line-of-credit loans are intended for purchases of inventory and payment of operating costs for capital and trade cycle needs. they are not intended for purchases of kit or land.
A line-of-credit loan may be a short-term loan that extends the cash available in your business’s bank account to the upper limit of the loan contract. Every bank has its own method of funding, but, essentially, an amount is transferred to the business’s bank account to hide checks. The business pays interest on the particular amount advanced, from the time it’s advanced until it’s paid back.
Line-of-credit loans usually carry a rock bottom rate of interest a bank offers since they’re seen as fairly low-risk. Some banks even include a clause that provides them the proper to cancel the loan if they think your business is in jeopardy. Interest payments are made monthly, and therefore the principal is paid off at your convenience, though it’s knowing to make payments on the principal often.
Most line-of-credit loans are written for periods of 1 year and should be renewed almost automatically for an annual fee. Some banks require that your credit line be fully paid off for seven to 30 days each contract year. this era is perhaps the simplest time to barter. albeit you don’t need a line-of-credit loan now, ask your banker about the way to get one. to barter a credit line, your banker will want to ascertain current financial statements, the newest tax returns, and a projected cash-flow statement.
2. Installment loans.
These loans are paid back with equal monthly payments covering both principal and interest. Installment loans could also be written to satisfy all kinds of business needs. You receive the complete amount when the contract is signed, and interest is calculated from that date to the ultimate day of the loan. If you repay installment credit before its final date, there’ll be no penalty and an appropriate adjustment of interest.
The term of an installment credit will always be correlated to its use. A trade cycle loan could also be written as a four-month installment credit from, say, September 1 until New Year’s Eve and would carry the low rate of interest since the danger to the lender is under one year. trade cycle loans could also be written from one to seven years, while land and renovation loans could also be written for up to 21 years. Installment credit is occasionally written with quarterly, half-yearly, or annual payments when monthly payments are inappropriate.
3. Balloon loans.
Though these loans are usually written under another name, you’ll identify them by the very fact that the complete amount is received when the contract is signed, but only the interest is paid off during the lifetime of the loan, with a “balloon” payment of the principal due on the ultimate day.
Occasionally, a lender will offer a loan during which both interest and principal are paid with one “balloon” payment. Balloon loans are usually reserved for situations when a business has got to wait until a selected date before receiving payment from a client for its product or services. altogether other ways, they’re equivalent to installment loans.
4. Interim loans.
When considering interim loans, bankers are concerned with who is going to be paying off the loan and whether that commitment is reliable. Interim loans are wont to make periodic payments to the contractors building new facilities when a mortgage on the building is going to be wont to pay off the interim loan.
5. Secured and unsecured loans.
Loans can are available in one of two forms: secured or unsecured. When your lender knows you well and is convinced your business is sound and therefore the loan is going to be repaid on time, they’ll be willing to write down an unsecured loan. Such a loan, in any of the aforementioned forms, has no collateral pledged as a secondary payment source do you have to default the loan. The lender provides you with an unsecured loan because it considers you a coffee risk. As a replacement business, you’re highly unlikely to qualify for an unsecured loan; it generally requires a diary of profitability and success.
A secured loan, on the opposite hand, requires some quite collateral but generally features a lower rate of interest than an unsecured loan. When a loan is written for quite 12 months, is employed to get equipment, or doesn’t seem risk-free, the lender will ask that the loan be secured by collateral. The collateral used, whether land or inventory, is predicted to outlast the loan and is typically associated with the aim of the loan.
Since lenders expect to use the collateral to pay off the loan if the borrower defaults, they’ll value it appropriately. A $20,000 piece of the latest equipment will probably secure a loan of up to $15,000; receivables are valued for loans up to 75 percent of the quantity due, and inventory is typically valued at up to 50 percent of its sale price.
6. Letter of credit.
Typically utilized in international trade, this document allows entrepreneurs to ensure payment to suppliers in other countries. The document substitutes the bank’s credit for the entrepreneur’s up to a group amount for a specified period of your time.
7. Other loans.
Banks everywhere the country write loans, especially installment and balloon loans, under a myriad of names. They include:
Term loans, both short- and long-term, consistent with the number of years they’re written for
Second mortgages where land is employed to secure a loan; usually long-term, they’re also referred to as equity loans
Inventory loans and equipment loans for the acquisition of, and secured by, either equipment or inventory
Accounts receivable loans secured by your outstanding accounts
Personal loans where your signature and private collateral guarantee the loan, which you, in turn, lend to your business
Guaranteed loans during which a 3rd party—an investor, spouse, or the SBA—guarantees repayment
Commercial loans during which the bank offers its standard loan for little businesses