With myriad varieties of loans and financing options available from banks of all sizes, you’ll need to know the which is option is best for you.
By: Phoenix Lee/
Much like trying to pick the right loan for a home mortgage, you’ll likely be overwhelmed by the many types of small business loans and financing options your bank makes available. And, much like a mortgage, one loan option usually floats to the surface as the best fit for you and your situation. Discerning which loan is the right choice isn’t necessarily a matter of one type being better than the other.
For financing options, focus on the two of major characteristics that vary among bank loans:
- The term of the loan
- The security or collateral required to obtain the loan
Understanding Loan Terms
The term of the loan refers to the length of time you have to repay the debt. Debt financing can be either long-term or short-term.
Common Applications for Long-Term and Short-Term Financing
Long-term debt financing is commonly used to purchase, improve or expand fixed assets such as your plant, facilities, major equipment and real estate.
If you are acquiring an asset with the loan proceeds, you (and your lender) will ordinarily want to match the length of the loan with the useful life of the asset. For example, the shelf life of a building to house your operations is much longer than that of a fleet of laptops, and the loan terms should reflect that difference.
Short-term debt is often used to raise cash for cyclical inventory needs, accounts payable and working capital. In the current lending climate, interest rates on long-term financing tend to be higher than on short-term borrowing, and long-term financing usually requires more substantial collateral as security against the extended duration of the lender’s risk.
Debt financing can also be secured or unsecured. Unfortunately, these terms don’t mean how secure or unsecure the debt is to you, but how secure or unsecure the debt is to the lender.
The Price of Secured Loans
No matter what type of loan you take, you promise to pay it back. With a secured loan, your promise is “secured” by granting the creditor an interest in specific property (collateral) of the debtor (you).
If you default on the loan, the creditor can recoup the money by seizing and liquidating the specific property used for collateral on the debt. For startup small businesses, lenders will usually require that both long- and short-term loans be secured with adequate collateral.
Because the value of pledged collateral is critical to a secured lender, loan conditions and covenants, such as insurance coverage, are always required of a borrower. You can also expect a lender to minimise its risk by conservatively valuing your collateral and by lending only a percentage of its appraised value. The maximum loan amount, compared to the value of the collateral, is known as the loan-to-value ratio.
For example, a lender might be willing to lend only 75 percent of the value of new commercial equipment. If the equipment was valued at $100,000, it could serve as collateral for a loan of approximately $75,000.
Revolving Debt and Unsecured Loans
In contrast with secured loans, your promise to repay an unsecured loan is not supported by granting the creditor an interest in any specific property. The lender is relying upon your creditworthiness and reputation to repay the obligation. The most ubiquitous form of an unsecured loan is a revolving consumer credit card. Sometimes, working capital lines of credit are also unsecured.
While your property may not be at direct risk, defaulting on a secured loan does carry serious consequences. True, the creditor has no priority claim against any particular property if you default, but the the creditor can try to obtain a money judgment against you.
Unfortunately for startups, financing options like Financingunsecured loans (at least ones with reasonable interest rates) are not usually available to small businesses without an established credit history. An unsecured creditor is often the last in line to collect if the debtor encounters financial difficulties. If a small business debtor files for bankruptcy, an unsecured loan in the bankruptcy estate will usually be “wiped out” by the bankruptcy, but no assets typically remain to pay these low priority creditors.
Credit is essential for financing the growth of innovative SMEs. Competition for funds are useful to create investment opportunities for the business. To be able to be eligible for the financing options banks provide, businesses must increase their efficiency and profitability.
How to Secure Small Business Loan Quickly
If you are searching for a small business loan, the loan consultants at iCompareLoan can set you up on a path that can get you a it in a quick and seamless manner. Our loan consultants have close links with the best lenders in town and can help you compare various loans and settle for a package that best suits your needs. Find out money saving tips here.
To find out more about Peer to peer lending versus that of SME loans so as to make an informed decision: SME Loans or Peer-to-peer (P2P) Lending – What is the difference?
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