A term loan provides you with a sum of cash that you must pay off within a specific length of time. A typical business loan ranges from 1 to 5 years- however, a long-term business loan may last up to 10 years.
This wide range of term lengths can be intimidating for small business owners, especially when it’s their first loan. Therefore, it’s important to take the time to research various business lenders and their terms. Before choosing a business term loan, you must ask yourself two questions:
How much working capital do you need?
What are you using the money for?
Though the terms of the loan are important, you need to have answers to these questions to choose the best option for you. You must choose your preferred term before starting the application. In this article, we’ll explain business loan terms to help you choose the right one. This will help you choose a loan term that will work for you and your business.
Business Loan Terms Explained
The term of a business loan is the time from the closing date of the loan and the date it is repaid or terminated. You may also hear this period referred to as “borrowing period” or “loan repayment period”.
Difference between Short, Medium, & Long Term Business Loans
If you are a small business owner that has been looking into financing, you’ve likely seen loans referred to as short-term, medium-term, and long-term. However, it’s unclear what is meant by each of those and how to choose the best term for your business needs. If you don’t choose the right one, you may hurt your financial future.
Here are some things to know about each one:
- Short-term: 1 year or less- microloans, bridge loans, line of credit
- Medium-term: 1 to 5 years- equipment financing, student loans
- Long-term: 5+ years- traditional business loan, SBA 7(a) loan, mortgages
Things to Consider When Weighing Your Options
The first thing you must do when choosing a small business loan is determine how you plan to use the funds. In addition, you should consider the following:
- Interest rate on the loan
- How cash flow will be affected
- To consider interest on the loan, it’s important to understand how the term affects interest.
- Interest Cost & Loan Term
Interest makes up most of the cost of your business loan. Since interest is paid over time, the term of the loan has an effect on how much you pay. Obviously, you want to avoid high interest rate loans.
When evaluating loan terms, you should keep in mind that you’ll pay more interest on a long-term loan than a short-term one. However, a long-term loan may still be your best option because a short-term loan must be paid off sooner, which may not be feasible.
Match Cash Flow with Business Loan Term
A major challenge for small business owners is maintaining a healthy cash flow. So when you get a business loan, it’s important to match the financing term with your current and future cash flow.
Short-term loans must be paid back faster, which means you will be making fairly large payments. The payments on a long-term loan are smaller but extend over a longer period of time.
Either way, it’s important to make sure payment dates and amounts align with your cash flow or your may end up with no cash on hand to make the payments. If this happens, you’re stuck with a substantial debt, which could harm the financial future of your business.
Some lenders are flexible on payment due dates so you can keep them from being due at the same time as other bills. As the business owner, you must stay on top of your financial obligations and make sure that you can afford them all.
Don’t forget your credit score
When you borrow money- whether a business loan or line of credit- the offer is likely going to be contingent on your credit score. Typically, business lenders prefer to work with business owners that have a strong credit history because they have a good track record of paying their bills. It may be possible to be approved with bad credit, but your terms may not be ideal.
If your score is low, consider taking steps such as:
- Consolidating debt
- Paying bills in full/on time
- Checking credit report regularly to ensure there are no errors
- Improve other areas of your business’ finances
Conclusion
Finding the right business loan is a delicate process. If you choose longer terms, you will pay more than you should in interest. On the other hand, if terms are too short, payments may be too high to manage.
If you struggle with repaying your loan, your business’s credit score is at risk, which is detrimental to your future ability to qualify for funding. To make the process easier, go back to the original questions and answer them. This will narrow down your options so you can compare the terms of those options. When you’re ready to apply for business financing, contact Hemmingway Financial Group and let our advisors help you weigh your options.