How Do Business Loans Work? The Ultimate Guide

Here's everything you need to know about how business loans work.

We discuss and explain how each part of the process works. We also give you a refresher on what these financial products are so you choose the best option to finance your company. Keep reading if you're ready to understand everything you want to know about getting capital to grow your company.

How Do Business Loans Work?

A loan is a contract between a borrower and a lender in which the borrower receives money or something of value from the lender in exchange for a promise to repay the money or its equivalent later.

A business loan is a loan specifically intended for commercial purposes. You borrow a certain amount of money from a lender, and then you use that money to finance your business.

As with all loans, it involves the creation of a debt, which you will repay with interest.

Different Types Of Small Business Loans And How Each One Works

Many types of business loans are available to entrepreneurs. The most common include:

Secured Loans

A secured loan requires you to offer some form of collateral to reduce the risk for the lender. If you default on your repayments, they have the right to seize the pledged asset. This allows the lender to recoup their losses. Due to this security, these loans often come with lower interest rates. The collateral you offer can be:

• real estate
• inventory
• other assets

The loan amount is typically proportional to the value of the collateral. Repayment terms usually involve regular monthly payments, which include principal and interest.

Unsecured Loans

Unsecured loans don't require collateral. Your creditworthiness is the main consideration here, so having a good credit score is essential. However, they typically come with higher interest rates if you have a less-than-stellar credit history due to the increased risk for the lender. Lenders evaluate your business's financial health, credit score, and revenue to approve the loan and choose the rates they'll offer. These loans may also have shorter repayment terms.

Term Loan

A term loan offers a lump sum of money upfront, with a set repayment term ranging from short to long-term: usually between 1 to 25 years. Interest rates accrue on the outstanding balance and they can be:

• fixed
• variable

After approval, businesses receive a lump sum, which they must repay, making monthly repayments (principal plus interest).

#DidYouKnow These are the most common types of small business loans.

SBA Loan

These loans are guaranteed by the US Small Business Administration (SBA). The SBA doesn't directly lend money. Instead, they guarantee a portion of loans made by their partners, which are usually banks. SBA loans are popular due to their competitive terms, large loan amounts, and longer repayment periods. The SBA's involvement reduces risk for the lender, often resulting in better terms for the borrower. Businesses must meet SBA's eligibility criteria, and the process can be lengthy.

Business Line Of Credit

A business line of credit gives you access to a set amount of funds—your credit limit—that you can tap into whenever you need. You only pay interest on the amount you use, and once you repay the borrowed funds, you can borrow again up to the original limit.

Merchant Cash Advances

With a Merchant Cash Advance—or MCA—a business receives a lump sum payment in exchange for a percentage of future credit or debit card sales. Each day, the lender deducts the agreed percentage from your sales till you pay off the advance. It's a speedy way to get funds but often comes with higher costs.

Invoice Factoring

Invoice factoring lets you sell your unpaid invoices to a third party at a discount. In return, you get immediate cash. The third party, or the factor, then collects the payment directly from your clients. The business gets immediate cash but at a lesser value than the total invoice amount.

Invoice Financing

Invoice financing, or accounts receivable financing, provides an advance on pending invoices (typically 85-90% of the invoice value). However, you're responsible for collecting payments from your clients. Once collected, you pay back the lender, typically with a fee.

Working Capital Loan

These loans are specifically to finance short-term, everyday operational needs and business operations. The loan amount depends on the business's operational costs. Repayment schedules vary but are typically shorter in duration. They are for wages or inventory, not long-term investments or large projects.

Equipment Financing

For businesses needing machinery, tech, or other equipment, equipment financing is ideal. The purchased equipment itself acts as collateral. Hence, if you default, the lender can seize the equipment. Loan amounts and terms align with the equipment's value and expected lifespan.

Commercial Real Estate Loans

When you want to buy commercial property or expand existing spaces, commercial real estate loans are the way to go. These loans have longer terms and can cover up to 90% of the property's value, and repayment terms are longer than other types of loans. The property often acts as collateral.

How The Business Loan Application Process Works

By understanding the process and knowing what to expect, you can make the process go smoothly and increase your chances of getting approved for business financing.

Most Common Business Loan Requirements

• A Track Record Of Success. Lenders favor businesses that can demonstrate stability and a history of profitability. It reassures them that you manage the company efficiently and t stands a good chance of repaying the loan. Evidence could include:
  • sales records
  • profit margins
  • other growth metrics
• Collateral. Some lenders will require collateral to secure the loan. It acts as a safety net for the lender. Should you default, they'll have something tangible to recoup their losses.
• A Good Credit Score. Your business's credit history reflects its financial health and reliability. Lenders often use this to gauge the risk associated with lending money. Generally, lenders require a minimum credit score of 660.
• A Strong Business Plan. Lenders want clarity on how you'll use the loan and how it'll drive your business forward. A well-crafted business plan showcases your vision, goals, market analysis, and financial projections.
• Good Cash Flow. Lenders assess this to ensure you have enough steady income to cover ongoing operational costs plus the new loan repayments.
• Consistent Earnings. A record of consistent earnings can instill confidence in lenders, indicating a financially sound operation.
• Enough Time In Business. Most lenders prefer businesses that have been operational for a reasonable period. It suggests resilience, experience, and a better understanding of the market dynamics.
• Low Debt Load. If too many debts, lenders may view your business as over-leveraged and a risky investment.
  • A Manageable Debt-To-Income Ratio. You typically need a ratio of 40% or less, which means that no more than 40% of the borrower's income should go towards debts (including the new loan payment).
• Industry. Certain sectors are riskier than others. While a thriving industry might make it easier to secure a loan, those in volatile markets might face stricter requirements or even be ineligible for certain loans.
• Personal Guarantee. A personal guarantee means that if the business fails to repay the loan, the individual providing the guarantee becomes personally responsible for the debt.

Applying

The loan application will ask for basic information about you and your business, such as:

• name
• address
• contact information
• revenue
• expenses

You'll also need to provide financial, business, and personal documentation. This is because lenders need tangible evidence of your business's financial health, and your paperwork does just that. Some examples of documents include:

• business and personal tax returns
• financial statements
• business licenses
• articles of incorporation
• bank statements
• legal documents

The lender will use all this information to determine whether you meet the minimum requirements. Apply For A Business Loan!

Underwriting

The lender's underwriting department will review it. Here's what they do:

1. Evaluation. The underwriter assesses your application, documents, and credit history. They ensure the information is accurate and assess the risk of lending to you.
2. Loan Terms And Conditions. Based on this assessment, the underwriter will determine the terms of your loan. This can include the interest rate, duration, and any covenants or conditions.
3. Collateral Appraisal. For secured loans, an appraisal of the collateral might be necessary to determine its value and sufficiency.

Approval And Closing

If the lender approves you, you will receive the loan proceeds and can begin using them in your business. If you are not approved, the lender will provide you with feedback on why your application was not approved and what you can do to improve your chances of getting approved in the future.

How Long Does The Business Lending Process Take?

The duration can vary based on several factors, like:

• type of loan
• lender's policies
• completeness of your application
• and more

For some working capital loans or MCAs, the process can be as quick as 24-48 hours from application to funding. However, more complex loans, such as SBA loans or commercial real estate loans, might take several weeks or even months due to their rigorous vetting processes and documentation requirements. Ensuring that you provide complete and accurate documentation can expedite the process.

#CaminoTip Having a good credit history and a robust business plan can make your application more attractive, potentially speeding up the approval time.

How Much Can I Get With A Business Loan?

Small business loans typically range from $5,000 to $500,000. The average loan size is around $50,000.

Factors That Affect The Loan Amount

• The Strength Of Your Business. Lenders will look at your financial statements, business plan, and other factors to determine whether or not your business is a good investment.
• Your Business And Personal Credit Score. Even if your business is doing well, you may not be able to get a loan if you have bad credit. That's because lenders see you as a higher risk if you have a history of not paying your debts on time.
• The Collateral You Offer. If your collateral isn't worth very much, you may not be able to get as much money as you want.

How Does Business Loan Repayment Work?

Small business loans come with a variety of repayment terms, depending on the type of loan and the lender. However, most of them require monthly repayments, similar to a mortgage or car loan. The lender determines the repayment schedule when you take out the loan and depends on factors such as:

• loan amount
• interest rate
• repayment term

Once you have agreed to the repayment schedule, it is important to stick to it to avoid any penalties or additional fees.

#CaminoTip If you are struggling to make repayments on your business loan, it is important to contact your lender as soon as possible.

Business Loans 101: The Basics

What Is A Business Loan?

Business loans are a type of financing that traditional such as banks, credit unions, and online lenders can offer you to grow your business. You can use the funds to expand, purchase new equipment or inventory, hire new employees, and more. Apply For A Business Loan!

Pros And Cons Of Commercial Loans

Pros:

• Helps With Cash Flow. Business loans can provide a much-needed financial boost to keep your business afloat during tough times. By taking out a loan, you can free up some of your own personal funds or business revenue.
• Builds Credit. Paying back a business loan on time can help build your company's credit score, which can be beneficial in the long run when you need to take out another loan or secure funding from investors.
• Gives You Access To Capital. Commercial loans give you much-needed access to capital to invest in your business to help it grow.
• Offers Flexibility. Many online lenders offer flexible repayment terms, so you can choose a repayment plan that works best for your business. This can be helpful if you have fluctuating or seasonal income.

Cons:

• High-Interest Rates. The biggest downside of commercial loans is the high-interest rates. Lenders consider businesses at higher risk than individuals, so they charge higher rates to offset that risk.
• Short Repayment Terms. Business loans also have shorter repayment terms than personal loans, which means you’ll need to pay back the loan much faster. This can be difficult if you don't have a steady income stream.
• Requires Collateral. Many business loans require collateral, such as your personal home or business asset. If you default on the loan, the lender can seize your assets to recoup their losses.
• It May Affect Personal Credit. If you take out a business loan in your name, it can affect your personal credit score. This is because the loan will show up on your personal credit report.

How You Can Spend Business Loans?

Small business loan uses vary from business owner to other. However, some of the more common uses include:

• Working Capital. You can use it to pay for day-to-day operations, like inventory, salaries, and other operational expenses.
• Expansion. You can use a business loan to finance a business’s expansion. This could include things like opening new locations, adding new products or services, or increasing marketing efforts.
• Equipment. Businesses often need to purchase new equipment as they expand or grow. You can use it to finance the purchase of this equipment.
• Real Estate. You can finance the purchase of the real estate. This could include office space, retail space, or other property types.
• Start-Up Costs. Finance the start-up costs associated with starting a new business. This includes things like licenses, permits, and other initial expenses.

There are many other uses for business loans as well. These are just some of the more common ones.

Where To Get Small Business Loans

Banks

Banks are one of the most common places to get a small business loan. They typically have the lowest interest rates and longest repayment terms. However, they also usually have the strictest eligibility requirements.

Credit Unions

They often have more flexible eligibility requirements than banks and may offer lower interest rates. However, credit unions typically have shorter repayment terms than banks.

Small Business Administration

The SBA doesn't lend money directly to businesses, but they do guarantee loans from participating lenders.

Online Lenders

They typically have lower interest rates but have shorter repayment terms. An online lender can be a good option for businesses that don't qualify for traditional loans.

Peer-to-peer lenders

Peer-to-peer (P2P) lenders operate online platforms that connect borrowers directly with individual investors. They offer a streamlined application process, potentially faster approvals, and competitive rates due to lower operating costs.

Alternative Lenders

Alternative lenders typically have higher interest rates, but they also have more flexible eligibility requirements.

How To Choose A Small Business Loan That Works For You

There are a few things you need to take into account when choosing a business loan.

• Figure Out How Much Money You Need To Borrow. This will help you narrow down your options and choose a loan that is right for you.
• Consider The Interest Rate. You want to find a loan with a low-interest rate so you can save money on the amount you borrowed.
• Repayment Terms. You want to find a loan with terms that are manageable for you. You don’t want to be stuck with a loan that has a long repayment period and high-interest rates.
• Fees Or Charges Associated With The Loan. Some loans have origination fees, closing costs, or other charges that can add up. You want to find a loan with low fees, so you don’t have to pay more than you have to.

Now you understand how business loans work; you can choose the right loan for you. When you consider all of these factors, you can be sure to find the best small business lenders that work for you. Apply For A Business Loan!

Tips To Qualify For A Small Business Loan

Following these tips can increase your chances of a lender approving you for a small business loan.

1. Make sure you have a well-written business plan outlining your company's goals and how you plan to achieve them. Your business plan should also include financial projections for the next few years.
2. Have a strong personal and business credit score. Lenders will pull your personal credit report when you apply for a business loan, so make sure there are no red flags on your report that could hurt your chances of approval.
3. Have collateral to offer as security for the loan. This could be in the form of property, equipment, or inventory.
4. Be prepared to answer questions about your business and why you need the loan. Lenders will want to know how you plan to use the loan proceeds and your repayment plans.

Camino Financial Makes The Difference: How Our Business Loans Work

At Camino Financial, we help pave the way for continued business growth by making the loan process simple and easy. We're an online lender that wants to help small businesses in the US grow and thrive. Here's how our small business loans work:

Our Small Business Loans

• Loan amount: $10,000 to $50,000
• Origination fee: 6.99%
• Type of rate: Fixed
• Repayment period: 24 months
• Payment frequency: Monthly
• Early prepayment penalty: None
• Collateral: None
• Time from application to funding: 10 to 12 business days

When we evaluate your application, we mainly consider your personal credit and the global cash flows of your business.

Our Benefits

• Convenience. Our online loan process is easy and is 100% online, so you can explore funding options from the comfort of your home or workplace.
• Freedom And Flexibility To Use Funds. You can use funds for most business needs. We have limited restrictions on fund usage.
• No Collateral Needed. Our small business loans are unsecured. That said, we do require a personal guarantee for some loans.
• Fixed Terms. You know exactly what you pay each month because the annual interest rate and the monthly payment stay the same. That way, you can avoid surprises and stay on top of your payments.
• You Can Pay Off The Loan Early. There are no prepayment penalties when paying off the loan in full before the loan term ends.

3 Easy Steps To Get A Loan

This is the simple and quick process you'll follow to obtain a business loan from Camino Financial:

1. Submit An Online Application. You can complete the mobile-friendly application in 15 minutes. You don't need to submit documents, and applying does not affect your credit score.
2. Complete The Process. If pre-qualified, a loan specialist will call you to ask for additional documentation or requirements, as well as your permission to digitally review the last months of your business bank activity.
3. Sign Loan Contract And Receive Your Funds. Once approved, we send a loan contract by email. Once you sign the contract, you receive funds deposited electronically to your bank account.

Apply For A Business Loan!