How Do Business Loans Work?

For entrepreneurs and small business owners, access to capital is often a key factor in realizing dreams and taking businesses to new heights. As a result, business loans are a valuable financial tool, providing the necessary funds for growth, expansion, and strategic investments.

In this comprehensive beginner’s guide, we’ll take a high-level look at how business loans work, from understanding the different types of loans available to the application process, eligibility criteria, and loan repayment. So, whether you’re a budding entrepreneur or an established business owner, this article will equip you with the basic knowledge you’ll need to navigate the world of business loans and make informed financial decisions. 

Types of Business Loans

Business loans come in various forms, each designed to cater to different business needs and circumstances. Some of the common types of business loans include:

Term loans: These loans provide a lump sum of capital that is repaid over a predetermined period, typically with fixed monthly payments. They are suitable for long-term investments or major purchases.

Lines of credit: Similar to a credit card, lines of credit offer businesses a predetermined credit limit that they can draw from as needed. Interest is only charged on the amount borrowed, making it a flexible financing option for short-term cash flow needs.

Equipment loans: These loans are specifically tailored for purchasing or leasing equipment. The equipment itself serves as collateral, making these loans relatively easier to obtain.

 Agency Guaranteed loans: Backed by various agencies, including the Small Business Administration (SBA), etc., these loans  are ideal for small businesses that may not qualify for traditional loans for various reasons.

Commercial real estate loans: These loans are designed for purchasing, renovating, or refinancing commercial properties. The property itself serves as collateral, providing security for the lender.

The Application Process

Applying for a business loan involves several steps, and the process may vary depending on the lender. However, here’s a general idea of the steps you can expect to take during the application process:

Research and preparation 

Determine the loan amount required and gather all necessary documents such as business financial statements, tax returns, business plan, and legal documentation.

Identify potential lenders 

Research and compare lenders to find the ones that offer the best terms and rates for your specific needs. Consider traditional banks, credit unions, online lenders, and agency or government-backed programs like the SBA, FAME, CEI, GPCOG, AVCOG, USDA Rural Development.

Submit the application

Complete the loan application form provided by your selected lender. Your application response should include accurate information about your business, financials, and loan requirements.

Documentation submission

Along with the application, submit the required documents such as financial statements, tax returns, and business licenses.

Underwriting and  loan decision

The lender will review your application and supporting documents, assessing your creditworthiness, business performance, and ability to repay the loan. They may also perform a credit check and request additional information if needed.

Loan offer and acceptance

If approved, the lender will provide a loan commitment that outlines the loan amount, interest rate, repayment terms, and any other conditions. Carefully review the offer, ask questions if necessary, consult with legal counsel if necessary, and then accept the terms if satisfied.

Eligibility criteria for business loans

Eligibility criteria play a crucial role in determining whether a business qualifies for a loan. Lenders assess various factors to evaluate the creditworthiness and financial stability of the business. 

Common eligibility criteria includes the location,  history and type of the business, the credit history of both the business and its owners, financial stability and performance, economic outlook for the business, collateral availability, and compliance with legal and regulatory requirements. 

The business’ age demonstrates its ability to sustain operations, while creditworthiness reflects the repayment history and reliability. Financial stability is assessed through factors such as revenue, financial trends, cash flow, profitability, net worth, and debt-to-income ratio. Collateral may be required to secure the loan, providing lenders with an alternative source of repayment in case of default.  Personal Guarantees are often required from the business owners, so the financial strength and creditworthiness of the owners is also assessed and factored into the loan decision process.

Finally, lenders verify that the business complies with applicable laws and regulations. Meeting these eligibility criteria increases the chances of loan approval and allows businesses to access the necessary capital for growth and expansion.

What is business loan repayment like?

When obtaining a business loan, borrowers agree to repay the loan amount along with any accrued interest within a specified timeframe. Repayment terms and conditions are outlined in the loan agreement and can vary depending on the loan type and other factors. 

Typically, business loan repayment involves making fixed monthly payments over the repayment period, although some loans offer more flexible options. It is essential for borrowers to understand the repayment schedule, interest rate structure (whether fixed or variable), and any associated fees or penalties. 

Making timely repayment is necessary in order to maintain a positive credit history and build trust with lenders. Late or missed payments may result in additional charges and penalties, potentially affecting the business’s creditworthiness. Some loans may also have provisions for early repayment or prepayment penalties. 

By adhering to the repayment terms and fulfilling their obligations, businesses can successfully repay the loan and potentially improve their credit standing, paving the way for future financing opportunities.

Putting it all together

Understanding how business loans work is essential for business owners  seeking to secure  capital for their business ventures. From different loan types to the application process, eligibility criteria, and loan repayment, navigating the world of business loans requires careful research and preparation. 

By equipping themselves with this knowledge, business owners can make informed decisions, find the right financing options for their businesses, and unlock opportunities for growth and success. Remember, choosing the right business loan can be a pivotal step towards turning entrepreneurial dreams into thriving enterprises.

Norway Savings Bank—Business Banking that starts with you

At Norway Savings, we have the privilege of working alongside business owners from start-ups to national expansions. We’re right there with you as you take that first step—and every step afterwards—to listen, strategize, celebrate and advocate. Our lenders have a broad range of experiences and can offer valuable insight and recommendations as you embark on a new path to build or expand your business. If it’s important to you, then it’s important to us. Check out Business Banking or let’s talk.