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What Affects Business Loan Terms?
January 03, 2018
What Affects Business Loan Terms

What Affects Business Loan Terms?

January 03, 2018
Despite the jargon that accompanies loan negotiations, the factors that affect business loan terms comes down to two simple things: risk and return. The bank or lender will want to make money on the deal, and lose as little as possible. Ultimately, their return on your loan depends on you repaying the loan, in addition to potential interest and fees.

If a bank or alternative lender is doubtful that you’ll pay back your loan, they may charge more in interest and fees. Thus, it’s a give and take between risk and return – if you’re seen as a risky borrower, you’ll see less satisfactory terms because the financier must justify taking a risk.

In this post, we’ll explain the factors that affect business loan terms. Keep reading to find out what they are!

Business and Personal Credit

The main principles of business loans don’t differ much from consumer loans like mortgages or student loans. You can expect a thorough credit check by almost any potential business lender. A poor credit score could increase your interest rates and fees on a business loan the same way it would on a mortgage.

In addition, don’t make the mistake of thinking lenders won’t care about your personal credit history. In most cases, your personal credit score will have just as big of an impact on your loan terms as your business credit score.

Your Business Plan

Fortunately for business owners without stellar credit, loan terms won’t solely rely on your credit history, especially if you apply for a loan through an alternative lender instead of a bank.

Remember, lenders want to provide your business with financing, but only if you’re worth the risk. To put their mind at ease, submit a professional and comprehensive business plan.

Although it won’t drive your loan costs down by itself, a professional business plan helps lenders understand the business they’re investing in. Therefore, the more that they understand your business, the more favorably they’ll look at you as an applicant.

Business History

The failure rate of new businesses has been well-documented, and business lenders are aware of this. This research can make it difficult for emerging businesses to attain financing, with many banks preferring loan applicants be in business for a minimum of three years.  Understandably, many businesses will require additional financing prior to the three-year mark, which is why it can make more sense to work with an alternative lender. Typically, they are less stringent about their time-in-business requirements, only requiring a business be operational for a few months.

Regardless, it is important to remember that the length of time that your business has been up-and-running can affect your loan terms. If you’re a new business owner, you can expect a healthy dose of skepticism from potential lenders, especially if they are banks. If you receive a bank loan, you’re likely to pay a higher interest rate or have a shorter payback period than a similar business with a longer track record.

The Size of Your Down Payment

How would you feel if you boarded a commercial airplane and the pilot already had a parachute on? Probably not very safe.

That’s sort of how it works with business loan terms. When the lender knows that you’re committed to your business, they’ll be more likely to provide you with better terms. Unfortunately, showing you’re dedicated doesn’t come cheap. A large down payment or significant personal equity in your business might be needed to show lenders that you’ll repay your loan. If you can’t afford to put up collateral, a bank could charge you extra interest and fees, or make your repayment period very short.

Type of Business

Certain types of business are riskier than others, and lenders know this. Even with a bog down payment and excellent credit, you could face a higher interest rate than a business in a more lucrative industry.

Consider the difference between starting a business that provides services to seniors – a booming industry – and starting a video rental business (a dying breed). Again, it boils down to risk and return. Chances are, with the number of people aged 65 and older “expected to nearly triple to 1.5 billion by 2050,” a business servicing senior citizens will receive a loan with better terms than a video rental business will.

Conclusion

 Clearly, loan terms depend on a variety of factors, both in and out of your control. It’s tough to get a conventional business loan with a low interest rate without a long and successful track record. Still, stay diligent –  if you can improve certain areas of your business that are mentioned in this post, you’ll hopefully be able to receive a loan with favorable terms.

Editorial Note: Any opinions, analyses, reviews or recommendations expressed in this article are those of the author's alone, and have not been reviewed, approved, or otherwise endorsed by any of these entities.

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