Must-Know Lending Terms Associated with Small Business Loans
Business loan as a product is quite commonly used by entrepreneurs to support their businesses. However, not all the terms that are fairly frequent in this lending business are understood by everyone. That is a reason why firm owners feel overwhelmed while deciding on applying for a small business loan. To make it simple for you to understand the concepts, we have chosen some most important terms and prepared brief explanations to those- alphabetically.
Annual Percentage Rate
The annual percentage rate (APR) is the total cost of the borrowed business loan per a year. APR is not the interest rate, although many people confuse both to be the same. While the interest rate shows what percentage of the principal one is paying as interest, APR covers interest plus other additional charges- origination fees, closing fees, documentation fees, etc. That is why APR gives the borrowers the exact figure of the cost they have to bear if they availed the loan. Therefore, while comparing loans from different lenders, one should compare the APRs and not just the interest rates.
Business Credit Score
Just as every individual has a credit score on the basis of the credit report by the bureaus, so does a business. A business credit score is also called a commercial credit score. This number helps the lender decide if the business should be approved with a funding or not. In case the business is small, the owner’s credit score will also be taken into consideration while deciding on lending money. If a business has a good history of repayments when it comes to credit obligations, the score is good- and the business qualifies for a higher amount of loan. It is also true that many private lenders finance businesses even with bad credit if they find their current sales to be satisfactory.
Business Line of Credit
A business line of credit is very similar to a regular credit card. Unlike a business finance, where one pays interest on the granted amount, in case of a line of credit the borrower pays interest on the amount that is used. For example, if the financing source sets the credit limit to $20,000, and the business owner uses $10,000 towards the firm, he only pays interest on $10,000. When the credit is paid, the status is automatically renewed, and the borrower can start using funds again up to the limited amount. Compared to a traditional business loan, however, the interest rates of these lines of credit might be higher.
Debt-Service Coverage Ratio
the Debt-Service Coverage Ratio (DSCR) is a figure that represents the availability of the cash flow in the business to pay outstanding debts. The debt includes all the principals, interest amount, lease payments and sinking-funds. If you have to put it in an equation, it would look like this –
DSCR = Net income of the business/ Total outstanding debt owed
Net income of the business, in this case, is the total sales of the business minus the maintenance charges (bills, employees’ salaries etc.).
If your business’s DSCR score is 1.25 or more, many lenders will readily grant you funding.
Income Statement
While filling up the small business funding application, you need to provide your business’s income statement. Income statement basically is the report of a firm’s performance over a time period; these financial reports are prepared usually monthly. Since it gives a detail report of the financial activities, company’s loss and profit can be measured through the statements. It is always a good idea to prepare the statement by being involved as the owner of the firm as the short term business loan approval depends on these financial statements considerably.
Personal Guarantee
A personal guarantee, in the lending business, is the acceptance of the legal obligation by the borrower to pay off the debt according to the conditions. That means, only the borrower would be responsible if s/he defaults the loan. This is an alternative to escape putting a collateral, and some lenders provide this option. Since there is no collateral put as a guarantee, defaulting loan with a personal guarantee could lead to seize of the personal properties- such as car or house. Before signing the contract, it is advisable to go through all the clauses and consult with an attorney.
SBA Loans
Small Business Administration (SBA) loans are guaranteed small business loans by the federal agency. Because of the flexible and longer terms, apart from the lower interest rates, these are popular among the business owners. However, it requires the business to be 2 years old with a good credit score to qualify for a business cash advance. Mostly, banks are the ones who provide these loans and there is a lot of competition among entrepreneurs to avail such loans. That means, getting an approval for an SBA loan is not very easy. The maximum amount that can be lent in an SBA loan is $5 million. However, because of bulks of paperwork, the process becomes lengthy.
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