How SBA Loans Are Different from Other Products
How SBA Loans Work
SBA loans have an approval process similar to traditional commercial loans. This is because when you receive an SBA loan, a bank lends you the money, while the SBA guarantees part of the loan.
It is important to note that the SBA doesn’t lend the money to small businesses. Instead, the SBA partners with banks and authorized SBA lenders. Luckily, because the SBA is guaranteeing the loan, it allows for many businesses to qualify for loans that might not qualify for traditional financing options.
Before applying for an SBA loan, there are four main requirements, which include:
- Be an officially registered business
- Conduct business in the U.S.
- Have equity in your business
- Exhaust other financing options
If you meet these requirements, you can begin the application process.
Like traditional loans, there is a lot of paperwork required when applying for SBA loans. Before starting your application, you’ll need to gather business and personal information along with tax documents. Then, you’ll have to complete the application and submit other paperwork. Find the application checklist here.
How Other Financing Options Differ
It’s important to understand how SBA loans fit into the financial product landscape. One of the best ways to do that is to compare them to other financial products.
Traditional Bank Loans – These types of loans are often difficult for small businesses and startups to qualify for. Most banks won’t work with recently opened businesses, and usually require an overall favorable financial history and high credit score. In comparison, because the SBA is guaranteeing the loan, risks are removed from lenders and transferred to the SBA. This reduces the qualification standards and allows more businesses to qualify for an SBA loan.
Line of Credit – A line of credit can be used at will. Once the line is provided, the business doesn’t have to get approval to “draw” from it, and can draw up to the limit.
Unlike an SBA loan, terms are not as stringent with a line of credit. Thus, there isn’t an amortization period with fixed monthly payments. In addition, interest rates on lines of credit are usually variable. This can be good and bad. The interest rate might be lower than that of an SBA loan, but can increase as FED rates rise.
In comparison, an SBA loan requires a lengthy approval process and is usually meant for a specific purpose. Although a line of credit can be difficult to get approved for, they are flexible in how they can be used.
Credit Cards – According to the SBA, 46 percent of small businesses use personal credit cards. Although credit cards are an easy source of financing, they must be managed responsibly to avoid having interest get out of control. In comparison to an SBA loan, credit cards have much higher interest rates.
When you apply for a business credit card, it will usually be beneficial if you have a good personal credit score. In addition, you might benefit from submitting your business’s credit score, so that you can show that you’ve managed your businesses finances appropriately.
There are rarely usage restrictions for credit cards. As we previously mentioned, this is not the case for SBA loans.
Merchant Cash Advance – When you receive a merchant cash advance, you’ll receive lump sum financing, without set terms. To remit a merchant cash advance, a percentage of your business’s credit card sales will be used to fulfill your obligation. This can benefit businesses because the process depends on the flow of their sales. This is unlike SBA loans, which will certainly have set repayment terms.
A merchant cash advance rarely has usage restrictions, while an SBA loan will have some limits depending on the product. In addition, it is important to note that if your business doesn’t accept frequent credit card payments, you likely won’t qualify for this product.
SBA loans can be difficult to qualify for and have a lengthy approval process. Still, they can be beneficial to business owners seeking financing. Before you apply, review the other options featured in this post to determine if you can receive one of them instead.
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.