Small business loans present a valuable opportunity for entrepreneurs looking to start or expand their ventures. Navigating the diverse range of loan options available can be daunting, making it essential to understand key terminology to make informed borrowing decisions. This article will clarify critical business loan terms you need to know. Let’s dive in!
Understanding Business Loan Terminology
Business loan terminology can often perplex small business owners. It encompasses the specific words and phrases used in the lending process. Key terms typically found in business loan agreements include principal, interest, maturity, and amortization.
Essential Business Loan Terms
A
Alternative Lenders
Alternative lenders refer to non-traditional financial sources providing lending options like merchant cash advances, encompassing online lenders and peer-to-peer platforms, as well as personal connections like family and friends.
Annual Percentage Rate (APR)
The Annual Percentage Rate (APR) indicates the yearly cost of borrowing, expressed as a percentage. It accounts for the interest rate on the loan and any additional charges.
Amortization
Amortization involves repaying a business loan through regular installments that consist of both principal and interest amounts.
B
Balloon Payment
A balloon payment is a significant payment due at the end of the loan term, often employed in shorter-term loans where the borrower requires more time to accumulate sufficient funds for repayment.
Bank Loans
Bank loans are loans provided by traditional banks or financial institutions.
Borrower
The borrower is the individual or business entity obtaining funds through a loan.
Borrower’s Monthly Payment
This term refers to the regular payment made by the borrower to the lender, typically encompassing both principal and interest amounts.
Bridge Loan
Bridge loans are short-term financial solutions designed to fill the gap between the need for immediate funds and the availability of longer-term financing. These loans usually last six months or less.
Business Credit Cards
Business credit cards are a strategic financing option, offering benefits such as cashback rewards and 0% APR introductory rates.
Business Line of Credit
A business line of credit provides access to a predetermined amount of money that can be withdrawn as needed for various business expenditures.
Business Loan Term
The business loan term refers to the duration during which the loan is valid, generally shorter than the time required for a business to generate enough revenue for repayment.
Business Plan
A business plan outlines a company’s objectives, strategies for achieving them, and includes vital details about products, marketing approaches, and financial forecasts.
Business Loan Terms & Rates
The terms and rates of a business loan describe the specific details surrounding the loan agreement, including the interest rate, repayment duration, and any applicable fees.
C
Capital
Capital refers to the financial resources a business utilizes to initiate or expand operations, which can include cash, equipment, inventory, or real estate.
Cash Flow
Cash flow signifies the movement of financial transactions in and out of a business, providing insights into its financial health and operational performance.
Cognovit Note
A cognovit note allows the lender to initiate legal proceedings against the borrower in the event of a loan default, typically applied when the borrower is deemed high-risk.
Co-borrower
A co-borrower is an individual or business that shares the obligation of repaying the loan alongside the primary borrower.
Collateral
Collateral consists of assets used to secure a loan, allowing the lender to reclaim these assets if the borrower defaults on repayment.
Cosigner
A cosigner is a person who agrees to share liability for the loan, usually a friend or family member with good credit, aiding in loan approval.
Credit Bureaus
Credit bureaus gather and maintain credit information, forming credit reports that reflect an individual’s or business’s creditworthiness.
Credit History
Credit history traces an individual’s or business’s previous financial transactions, impacting their credit score and overall credit report.
Credit Limit
The credit limit indicates the maximum amount a business can borrow against its credit card, with potential repercussions on credit score if surpassed.
Credit Line
A credit line, similar to a business credit card, grants access to a set amount of borrowed funds and usually features lower interest rates.
Credit Report
A credit report details a person’s or business’s credit history, inclusive of transactions and credit score information.
Credit Score
Your credit score serves as an indicator of creditworthiness, influencing a lender’s decision on loan eligibility.
D
Debt Consolidation
Debt consolidation involves merging multiple debts into a single loan, often resulting in more favorable terms, such as reduced interest rates or manageable monthly payments for businesses.
Debt Instruments
Debt instruments are tools utilized by businesses for borrowing, including business loans, lines of credit, and credit cards.
Debt-to-Income Ratio
This ratio measures a business’s total debt in relation to its income, serving as an indicator of financial health and risk.
Default
Default occurs when loan payments are not made per agreed terms, potentially harming credit score and prompting legal action from lenders.
E
Existing Loan
An existing loan refers to a loan already approved and actively being utilized by a borrower.
Equipment Financing
This financing type aids businesses in purchasing necessary equipment, typically involving large investments in vehicles or machinery.
Equity
Equity denotes the ownership stake funded through the owner’s capital, serving as collateral for business loans that lenders can reclaim if the borrower defaults.
Equity Financing
Equity financing raises capital by selling shares of the business to investors, granting them ownership stakes and a share of profits while also exposing them to business risks.
F
Fair Market Value
Fair market value is the mutually agreed price between a buyer and seller, often utilized for assessing business or asset worth.
FICO Score
The FICO score is a widely used credit scoring model reflecting a person’s credit history and plays a critical role in loan approvals.
Fixed Interest Rate
A fixed interest rate remains unchanged throughout the loan term, providing borrowers certainty about monthly payment amounts.
G
Grace Period
A grace period offers borrowers time to make payments without incurring penalties.
Gross Income
Gross income encompasses the total revenue generated by a business before any deductions, crucial for determining debt obligations.
Guarantor
A guarantor commits to repaying a loan should the primary borrower default, often required for businesses with limited credit histories.
H
Hard Credit Check
A hard credit check measures a borrower’s creditworthiness, conducting a more in-depth review than a soft credit check and potentially impacting their credit score.
I
Interest Payments
Interest payments are fees for borrowing, generally calculated as a percentage of the loan amount and payable monthly.
Invoice Financing
Invoice financing provides businesses with immediate cash by using outstanding invoices as collateral, enabling the purchase of essential goods.
L
Lien
A lien is a legal right against assets securing a loan, allowing a lender to reclaim those assets if the borrower defaults.
Loan Agreement
This document outlines the specific terms and conditions of a loan, such as interest rates and repayment schedules.
Loan Amount
The loan amount is the total financial amount borrowed from a lender.
Loan Commitment
A loan commitment formalizes the loan terms and conditions, typically used to secure financing for future transactions.
Loan Covenant
A loan covenant imposes specific conditions on the borrower regarding financial practices and secured actions during the loan’s duration.
Loan Documents
Loan documents consist of the necessary paperwork for securing a loan, normally including the loan agreement and commitment letters.
Loan Principal
The loan principal represents the borrowed amount, crucial for calculating monthly payment obligations.
Loan Servicing
Loan servicing refers to managing the administrative aspects of a loan, from disbursement to final repayment.
Loan to Value
Loan to Value (LTV) ratio indicates the loan amount concerning the collateral value, aiding lenders in assessing lending risk.
M
Merchant Cash Advance
A merchant cash advance allows businesses quick access to necessary funds, offering an alternative financing solution.
Monthly Payments
Monthly payments refer to the regular amount owed to the lender by the borrower.
N
Net Income
Net income is the total earnings of a business after all expenses have been accounted for, serving as a key metric for profitability.
Non-Recourse Loans
A non-recourse loan implies no collateral is required for securing the loan, shielding the borrower’s assets from seizure in case of default.
Net Worth
Net worth indicates the total value of assets minus liabilities, a crucial measure of financial stability and repayment capability.
O
Origination Fee
An origination fee is assessed by the lender at loan inception, typically expressed as a percentage of the total loan amount.
P
Personal Guarantee
A personal guarantee binds the business owner to repay the loan, generally used to secure lender financing.
Personal Loan
Personal loans are issued to individuals for private, non-business purposes.
Pre-Payment Penalty
A pre-payment penalty imposes a fee for early repayment of a loan.
Pre-qualification
Pre-qualification assesses a borrower’s creditworthiness through a preliminary evaluation, typically via a soft credit check.
Prime Rate
The prime rate serves as the benchmark interest rate for the most creditworthy borrowers, influencing other loan rates.
Principal and Interest
Principal refers to the money borrowed, while interest is the fee charged for borrowing that amount.
Principal Balance
The principal balance signifies the remaining amount owed on a loan, crucial for payment calculations.
Promissory Note
A promissory note secures a loan and includes the terms and conditions agreed upon by both parties.
R
Recourse Loans
Recourse loans allow lenders to seize collateral in the event of default, giving them more security than non-recourse loans.
Refinance Transaction
Refinancing entails obtaining a new loan to pay off an existing loan, often to secure better terms.
Repayment Period
The repayment period designates the timeline allotted to repay a loan, generally structured in monthly installments.
Repayment Terms
Repayment terms detail how and when the loan must be repaid, including payment frequency and amount.
Revolving Credit
Revolving credit enables businesses to borrow up to a specified limit and repay over time, ideal for operational expenses.
S
Secured Loan
A secured loan is backed by collateral, protecting the lender’s interests in case of default.
Short-Term Business Loans
Short-term loans cater to immediate business needs and usually have repayment periods ranging from months to a few years.
Small Business Loan
Small business loans are designed solely for business purposes, often featuring lower interest rates than personal loans.
Soft Credit Check
A soft credit check evaluates creditworthiness without impacting the borrower’s credit score.
Subprime Loan
Subprime loans are issued to borrowers with lower credit scores, leading to higher interest rates due to increased risk.
T
Term Length
Term length represents the number of months or years for which a loan is taken, affecting repayment amounts and total interest.
Title Insurance Company
Title insurance companies protect lenders against potential title issues, safeguarding their financial investment.
U
Underwriting
Underwriting evaluates a borrower’s creditworthiness, assessing various factors to gauge the risk of loan repayment.
Unsecured Loan
Unsecured loans do not require collateral, bringing higher interest rates to offset lender risk.
V
Variable Interest Rate
A variable interest rate fluctuates throughout the loan’s life, often tied to an index that impacts borrowing costs.
W
Working Capital Loan
Working capital loans finance daily business operations, including expenses like inventory and payroll, essential for maintaining liquidity.
Four Main Types of Business Loans
Small business owners have various lending options at their disposal. Here are four primary types of business loans:
- Term Loans: Typically issued for larger sums, with repayment periods ranging from one to five years, often featuring fixed interest rates.
- SBA Loans: Government-backed loans offering repayment terms from seven to 25 years through the Small Business Administration.
- Invoice Factoring: Uses outstanding invoices as collateral to provide instant liquidity, allowing businesses to access a portion of invoice value upfront.
- Microloans: Designed for smaller loan amounts, usually under $50,000, with shorter repayment durations than traditional loans.
Avoiding Common Business Loan Pitfalls
While business loans can be incredibly beneficial, it’s crucial to avoid common mistakes when pursuing financing. Here are several pitfalls to watch out for:
- Overlooking Loan Terms: Not fully understanding loan agreements can lead to unanticipated costs.
- Borrowing More Than Necessary: Taking on excessive debt can jeopardize financial stability.
- Neglecting Credit Score: Your credit score directly influences borrowing terms; ignoring it can lead to unfavorable conditions.
- Ignoring Hidden Fees: Be aware of additional charges that could raise overall loan costs.
- Misjudging Repayment Ability: Overestimating repayment capacity can result in financial stress and potential default.
- Failing to Compare Offers: Exploring various lenders can yield better loan rates and terms.
- Not Having a Clear Purpose: Borrowing without a defined strategy may lead to indistinct financial outcomes.
- Not Reading the Fine Print: Carefully review all loan documents to prevent surprises.
- Ignoring Market Trends: Considering economic conditions is crucial for ensuring repayment capability.
- Rushing the Process: Hasty decisions can lead to regrettable borrowing choices.
By recognizing these pitfalls and taking a careful approach, small business owners can navigate the lending landscape, make astute borrowing decisions, and minimize financial setbacks.