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In their book Start your own business, the staff of LikendisLike Media Inc. guides you through the essential stages of starting your business, then helps you survive the first three years as a business owner. In this edited excerpt, the authors describe the seven different types of loans you could get from a bank.
When looking for debt financing for your business, you can turn to many sources, including banks, commercial lenders, and even your personal credit cards. And you don’t need to pinpoint the type of loan you need before approaching a lender; they will help you decide which type of financing best suits your needs. However, you should have a general idea of the different types of loans available in order to understand what your lender is offering.
Here is an overview of how lenders typically structure loans, with common variations.
1. Line of credit loans.
The most useful type of loan for small business owners is the line of credit loan. In fact, it is probably the only permanent loan agreement that every business owner should have with their banker, as it protects the business from emergencies and blocked cash flow. Line of credit loans are used to purchase inventory and pay operating costs for working capital requirements and business cycles. They are not intended for the purchase of equipment or real estate.
A line of credit loan is a short-term loan that extends the cash available in your company’s current account to the upper limit of the loan agreement. Each bank has its own financing method, but essentially an amount is transferred to the company’s current account to cover checks. The business pays interest on the actual amount advanced, from the time it is advanced until it is repaid.
Line of credit loans generally carry the lowest interest rate offered by a bank, as they are considered to be fairly low risk. Some banks even include a clause that gives them the right to cancel the loan if they think your business is in danger. Interest payments are made monthly and the principal is repaid at your convenience, although it is wise to make payments on the principal often.
Most line of credit loans are made for one year periods and can be renewed almost automatically for an annual fee. Some banks require your line of credit to be fully repaid for seven to 30 days per contract year. This period is probably the best time to negotiate. Even if you don’t need a line of credit loan now, ask your banker how to get one. To negotiate a line of credit, your banker will want to see the current financial statements, the latest tax returns and a cash flow forecast.
2. Installment loans.
These loans are repaid in equal monthly installments covering both principal and interest. Installment loans can be drawn up to meet all types of business needs. You receive the total amount when the contract is signed and interest is calculated from this date to the last day of the loan. If you repay an installment loan before its final date, there will be no penalty and an appropriate interest adjustment.
The duration of an installment loan will always be correlated to its use. A business cycle loan can be in the form of a four-month installment loan from September 1 to December 31, for example, and would carry the low interest rate since the risk to the lender is less than one year. Business cycle loans can be taken out from one to seven years, while home and renovation loans can be taken out for up to 21 years. An installment loan is sometimes written with quarterly, semi-annual or annual payments when monthly payments are inappropriate.
3. Loans of balloons.
Although these loans are generally written under another name, you can identify them by the fact that the total amount is received when the contract is signed, but only the interest is paid during the term of the loan, with a “balloon” payment. of the principal due on the last day.
Occasionally, a lender will offer a loan in which interest and principal are paid with a single “balloon” payment. Balloon loans are generally reserved for situations where a business must wait for a specific date before receiving payment from a customer for its products or services. In all other respects, they are the same as installment loans.
4. Interim loans.
When considering interim loans, bankers wonder who will repay the loan and whether this commitment is reliable. Interim loans are used to make periodic payments to contractors who are building new facilities when a mortgage on the building is used to repay the interim loan.
5. Secured and unsecured loans.
Loans can take two forms: secured or unsecured. When your lender knows you well and is confident that your business is sound and that the loan will be paid back on time, they may be willing to take out an unsecured loan. Such a loan, in one of the aforementioned forms, does not include any collateral as a secondary source of payment in the event of default. The lender offers you an unsecured loan because it considers you to be low risk. As a new business, it is very unlikely that you will be eligible for an unsecured loan; this generally requires a history of profitability and success.
A secured loan, on the other hand, requires some sort of collateral but usually has a lower interest rate than an unsecured loan. When a loan is taken out for more than 12 months, is used to buy equipment, or seems risk-free, the lender will ask that the loan be secured by collateral. The collateral used, whether real estate or inventory, should survive the loan and is generally linked to the purpose of the loan.
Since lenders expect to use the collateral to repay the loan if the borrower defaults, they will assess it appropriately. New equipment of $ 20,000 will probably guarantee a loan of up to $ 15,000; receivables are valued for loans up to 75% of the amount due; and inventory is generally valued at up to 50 percent of its selling price.
6. Letter of credit.
Generally used in international trade, this document allows entrepreneurs to guarantee payment to suppliers from other countries. The document substitutes the bank’s credit with that of the entrepreneur up to a fixed amount for a specified period of time.
7. Other loans.
Banks across the country are taking out loans, especially installment loans and hot air balloons, under a multitude of names. They include:
- Term, short and long term loans, depending on the number of years for which they are subscribed
- Second mortgages where real estate is used to secure a loan; usually long term they are also called equity loans
- Inventory and equipment loans for the purchase and warranty of materials or inventory
- Loans receivable guaranteed by your unpaid accounts
- Personal loans where your signature and your personal guarantee guarantee the loan that you in turn lend to your business
- Secured loans in which a third party – an investor, a spouse or the SBA – guarantees repayment
- Commercial loans in which the bank offers its standard loan to small businesses