When you’re trying to start or grow a small business, business loan financing can be a major lifeline. Small business loans give qualified businesses access to the money they need to cover the costs of operating and building a business.
From the paychecks of a few new employees to major purchases like equipment or real estate, small business loans are great resources for entrepreneurs looking for small business funding. However, loans are not gifts. They always have strings attached, and it’s crucial to understand the terms for repaying business loans.
Failure to repay a loan or meet the loan terms can have severe consequences, including hits to your personal credit score or a lien on your business. The strategies for repaying business loans outlined here can help you avoid penalties and keep your business in good standing to reach its financial goals.
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How to repay business loans
Generally speaking, business loan terms are similar to any other loan you may have taken out, like a car loan, private student loan, or mortgage. Once approved, you receive a lump-sum payment of the loan amount, then must repay the money you borrowed over time, plus interest and fees.
Usually, business loan terms call for monthly payments for a specified period of time, but sometimes you may have to make payments daily, weekly, or in other time increments.
Like personal loans, business loans may be either secured or unsecured. A secured loan is one that requires collateral to back the loan, like property, equipment, cash, or investments.
If you fail to repay the loan, the lender may repossess this collateral. An unsecured loan, on the other hand, does not require collateral. Rather, you will most likely have to sign a personal guarantee saying you will repay the business debt out of your personal assets if the business fails to repay the loan.
There are many types of business loans, but these are some of the most common:
Term loans for businesses
A business term loan is a traditional loan in which a lender gives an approved business a lump sum of money in exchange for business repayment terms.
These loans can be used for operating expenses, acquiring equipment or real estate, and much more. Because they’re so common, terms are highly variable and will often depend on the business owner’s financial profile, the business’s current financial situation, and the amount of money requested.
Different lenders have different limits and requirements, but repayment terms may extend to up to 20 years, loan amounts may go up to several million dollars, and interest rates typically start around 6%.
Term loans also include microloans, which have much lower maximum amounts and shorter repayment terms.
Private lenders tend to have the highest interest rates and fewest protections for businesses. Although you may have flexible repayment options, a standard repayment plan includes monthly payments.
Online lenders often offer even more flexibility for businesses. Another important factor to consider is secured vs. unsecured loans for your business.
If your loan is secured, that means that repayment is connected to some asset that your business owns, like equipment or commercial real estate. If you fail to pay, that asset could be forfeited to cover the repayment cost of the loan.
Pros of Term Loans
- Flexible limits between lenders.
- Few restrictions on how you spend the money, making them good for businesses investing in growth.
- Many lenders and loan products available, allowing businesses to shop for the best terms.
- Can be easier to qualify for than government-backed loans, making them better for new businesses.
Cons of Term Loans
- Interest rates can vary widely between lenders.
- Personal guarantee or collateral are almost always required.
- Poor choice for business owners with bad credit, as they’ll likely have to accept worse terms or have a loan application denied.
- Typically not attainable as startup loans since most lenders want to see at least a year in business to approve a term loan.
SBA loans
SBA loans are partially guaranteed by the American Small Business Administration (SBA), meaning that if a business defaults on the loan, the SBA will pay a portion of the amount owed to the lender.
This partial guarantee lowers the risk of the lender not getting any money back, making it more likely to extend a loan to a business it might not otherwise approve. It’s not a subsidized loan, but it can help some businesses get an approved loan agreement.
However, because SBA loans lower the risk for lenders and borrowers alike, they have much more rigid qualification requirements and a slow approval process. The SBA recommends a personal credit score of at least 640 to qualify and the most common loan program, 7(a), may take up to 90 days for approval . (If you have bad credit, you may need a cosigner.)
SBA loans tend to have higher interest rates, but start at a somewhat competitive 11.5% for well-qualified borrowers . Loan amounts typically range from $30,000 to $5 million and have extended repayment terms of up to 25 years .
Pros of SBA Loans
- Partial guarantee limits your personal liability for repaying the loan.
- High limits make them good options for small businesses looking to grow fast.
Cons of SBA Loans
- Difficult to get approved, making them a bad option for borrowers with bad credit.
- Slow approval process makes them poor choices for businesses that need cash fast.
- Interest rates tend to be high, making them less ideal for businesses with tight margins.
Business lines of credit
A business line of credit, while technically not a loan, is a short-term financing type that gives small business owners a line of credit to draw upon when they need cash. It’s like a mix between a working capital loan and a business credit card.
While your business is approved for a maximum amount, you don’t actually pay any interest on that amount unless you draw on the available credit.
Business lines of credit usually have lower limits than loans and are calculated based on your personal and business finances. They have the highest interest rates of common loan options and typically have repayment terms of 3 to 5 years. Annual percentage rates (APR) vary between financial institutions.
Pros of Business Lines of Credit
- Readily available cash is great for businesses that just need a little working capital from time to time.
- Interest is only charged on the amount you draw, so you don’t have to take on any debt unless you really need to.
Cons of Business lines of Credit
- Lower limits make it difficult for growth-minded businesses to use a line of credit to expand.
- High interest rates make it absolutely imperative that you not draw more than you can afford to pay back quickly.
Can you change your business loan repayment terms?
Things change, and sometimes projections don’t pan out. While it’s always important to only accept business loan terms that you know you’ll be able to satisfy, it is possible to change your business loan repayment terms in some cases.
The best way to adjust how you’re repaying a business loan is to refinance the debt repayment plan. As the Federal Reserve changes interest rates over time, your business may be able to refinance a loan into a lower interest rate or ask for loan repayment adjustments by contacting the lender.
If your business is struggling to meet a high monthly payment, or if rates have changed significantly since you opened the loan account, a lender may be willing to increase the term length to lower the monthly payment.
If you’re concerned your loan may go into forbearance, talk to your loan servicer. They can discuss refinancing options with you, but remember that you’ll pay a fee whenever you refinance.
Origination fees or refinancing fees may cost anywhere from 2-5% of the loan amount, so you’ll need to make sure the savings you’ll get from lowering the interest rate or extending the terms are worth the extra cost.
Depending on the loan balance, some lenders may allow you a grace period to make a payment or put a high interest loan into deferment until you have some more financial flexibility.
If you have several loans, building a new consolidation loan may be necessary to pay them all off. Unlike the avalanche method of paying off loans with the highest interest first, a consolidation loan helps you become debt-free by setting up a new loan with a new minimum payment for the life of the loan.
Tips on budgeting for business loan repayment
Meeting your business loan terms is vital to keep your small business in good financial standing. These tips can help ensure you don’t fall behind on payments.
- Set up autopay
One of the simplest things to do to avoid accidentally missing a payment is to set up autopay. Most lenders offer an online portal to view your loan balance and manage your loan. There, you can set up automatic payments from your bank account to ensure you don’t go into forbearance because you simply forgot to make business loan payments.
- Set some money aside
It’s a good idea for any small business to have a rainy day fund or some cash reserves in case business slows down or there’s an economic downturn. Likewise, after you’ve taken out a loan, setting some extra money aside each month will help you prepare for lean months. Setting up a save plan will help you prepare for tough times.
- Build payments into your budget
Every business has an operating budget to pay employees, afford raw materials, pay the office rent, and all the other expenses a business has every month. When you have a debt, it’s crucial to prioritize your monthly loan payment at the top of your budget. When money is tight, make some cuts in other areas before you opt to miss a loan payment.
Every month, your monthly payment should be a top priority in your business’s operating budget. Less essential things like business travel, client lunches, or merchandise should go on the chopping block before missing a payment.
- Track spending closely
For many businesses, one of the main reasons they got a loan was to invest in growth. Growth comes with additional expenses and it may become more challenging to track spending.
Depending on your budget, it’s crucial to hire an accountant or bookkeeping service to keep up with the company’s financials. Whether it’s a full-time or part-time employee, a contractor, or third-party software or service, having strong bookkeeping will help you understand your business’s cash flow after you’ve used the loan to invest in growth.
That way, you’ll better understand your monthly expenses and ensure you always have the money available to repay the loan, or have clarity to readjust your loan repayment terms, if needed. (Not to mention, clear accounting helps avoid misusing loan funds.)
- Make extra payments if you can
Depending on your business loan terms, you may be able to pay extra each month or make additional payments to pay the loan off early. When your business experiences a windfall or you get a big tax refund, it’s not a bad idea to take some of that surplus revenue and pay down your principal balance. That will save you interest charges in the long term and may even allow you to pay off the loan early.
Of course, the downside is that you won’t be able to reinvest that money in your business or pay it out to investors as profits. A loan calculator can help you figure out how much you may save by making an extra payment here and there.
- Be transparent with your lender
Running a business is hard, and things don’t always go how you hope. If at any time you think you might miss a payment, let your lender know ahead of time. In addition to extending the repayment period to get the next payment in, a lender may have repayment assistance programs to help businesses struggling to pay back loans.
Your lender doesn’t want your loan to go into forbearance or default. They want their money, even if they don’t recoup the total interest over the life of the loan.
Working with the lender, you may be able to put some interest into deferment or develop a repayment strategy that works better for your business. Whether it’s an income-driven repayment plan or an extended repayment term.
What happens when you don’t repay your business loan?
Failing to repay a business loan can have serious consequences. Even though all business owners are required to separate personal finances from business ones, personal assets aren’t always protected if you default on a business loan.
If you default on a business loan, you may face these consequences:
- Owe penalty fees for failing to pay the loan on time.
- A negative hit to both your business and personal credit scores on your credit report.
- Receive a lien on your business, preventing you from getting additional financing or selling any business assets.
- The lender may seize the collateral you used to secure the loan, whether it was business assets like construction equipment or personal assets like significant stock holdings.
- Defaulting on an SBA loan will require you to repay the federal government under a new repayment plan.
Conclusion
Business loans can be a great way to get your business off the ground or help it expand into new markets. However, repaying business loans isn’t always easy, especially if things don’t go as well for your business as you hoped.
Nonetheless, you must find ways to meet loan repayment terms or you’ll face serious consequences for both your business and personal assets. These strategies, from setting up tighter bookkeeping to making surplus payments when possible, can help your business avoid defaulting on a loan.
FAQs
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What is an effective strategy for business loan repayment for small businesses?
There are many good strategies to help a business repay a loan, but the best are fairly straightforward. Hiring an accountant or bookkeeping service to better track your spending, and always building your loan repayment into your monthly operating budget will help your business stay compliant with the business loan terms.
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How can a small business repay its business loans faster?
Some lenders include penalties for early or excess payments in the business loan terms. If that’s not the case, however, small businesses can repay business loans faster by using profits or surplus revenue to pay down the principal balance each month.
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What are easy ways small businesses can improve their budgets when repaying business loans?
Having an accountant or bookkeeping service categorize all of your business’s spending makes it easier to understand where your business may have some room to cut back. If you’re overpaying on non-essential things like business travel, client lunches, or merchandise for employees, these are easy items to cut back on to make sure you repay your debts.
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What happens when small businesses don’t repay business loans?
When small businesses go into default on a business loan, they may face a lien on their business or lose the collateral used to secure the loan. Not only will they owe penalty fees, but they’ll have to satisfy the loan terms by handing over collateral like equipment or real estate to the lender, and will not be able to get additional loans or sell their own assets until the debt is repaid. Not only that, but small business owners may see their personal credit score take a hit and have a more difficult time getting a loan in the future.
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