Understanding Small Business Loan Terms
When it comes to obtaining a small business loan, understanding exactly what you’re agreeing to is just as important as collecting all the documents you need and completing the application process accurately.
You want the best terms that truly fit your business, your financial needs, and limit your risks, so reading the fine print is a vital step in your process of searching for a small business loan.
Reading all the fine print is an important step in choosing a loan product.
Lenders and their loan products can vary greatly, and some will be a better fit for your business than others.
According to sba.gov, when it comes to loan agreements, the details hold the key as to whether one is a good fit or not. So it is crucial that you take the time to read through all the fine print, typically located in the promissory note (or security interest section) of your loan agreement.
What is Not So Obvious
Often the most important terms of the loan agreement aren’t made obvious to the borrower. The wording of the agreement may not always be as clear and easy to understand as you would, and sometimes it can be confusing. But, hidden within the small print can be some of the most complex and detailed restrictions or technicalities regarding the terms. There could be specific qualifications you must conform to and in some instances, that may not be explained in simple to understand language before you sign.
- If your interest rate will be fixed or variable (and if variable when does that change)
- The structure of your payment schedule, if there is a grace period without interest being charged and what late payment fees will be tacked on should you miss your payment due date.
- If there are prepayment penalties should you pay off your loan early
- A clear definition of what constitutes default of the loan and the penalties that will be incurred
There is great risk in getting excited about the loan and overlooking or not reading and understanding all of the loan’s tiny details. This can cost you down the road and even put your business at risk.
A good tip is to research the company you are about to do business with and look for information about any complaints made against them regarding any unfair terms or hidden costs. Comments from fellow borrowers can often tell you what you can expect, good or bad.
How to Understand Your Small Business Loan Terms
There are a few terms you must understand before you agree to the loan.
- Variable or (adjustable) interest rate: Your rate of interest is subject to change, according to Investopedia.com. As interest rates rise, so does your monthly payment, which is “adjusted” to reflect the new interest rate. Over long periods of time, interest rates typically do increase.
- An interest-only loan: This is where you pay a fixed interest rate for the first 1-5 years, which is usually a really low monthly amount because during this time, it is only to cover the interest. Then, the payment rises as part of it goes toward the principle as well and your interest rate becomes adjustable, meaning it will probably rise.
- Working Capital: This is the money you have or need for daily operations of your small business.
- Restrictive Covenants: This is a legal way to restrict management of your business during the life of the loan. It ensures that you will repay the loan before paying bonuses, dividends, and other optional payments you may have within your business.
No Surprises Please
Avoid surprises by taking the time to read all your loan-related documents in their entirety as early as you can. Ask your lender if you can see an example of the loan agreement, even before you’ve submitted your loan application.
Most conventional lenders have a myriad of terms you must read through. According to aboutmoney.com, the big banks, the Small Business Administration and credit unions, may have terms that are difficult to navigate and they may not meet your needs, but alternative funding solutions are available.
Alternative lenders are becoming the most popular method of lending for small business owners because they provide a loan product that fits their needs today at terms that are straightforward and easy to understand. They can provide several funding options, including small business loans, with a focus on ease in the qualification process, speed in getting you your money, and flexibility in the terms and repayment schedule.
With several small business loan options available to you, it is vital that you read and understand exactly what you are signing up for. To learn more about modern creative business funding options, contact Credibly today!