In this age of quick and short funding, it’s understandable that small business owners might overlook installment loans. After all, they require more documentation than some of the other types of loan products on the market.
But this type of loan – where you get a lump sum that you pay back over a predetermined period of time – gives you predictability and a fixed interest rate, which can prove to be beneficial as you grow. your business.
“I like installment loans because, with other loan products, the payment can vary and the APR is not clear,” Joseph Meuse, founder and president of Business GPS, told business.com. “A lot of business owners know how to deliver a product or service, but they’re not CFOs. The loan product is easy for them to understand and budget for. “
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How do business installment loans work?
Commercial installment loans work like a mortgage or car loan: you borrow a lump sum and have to pay it back over 12, 24, 36, 48, or 60 months, sometimes longer. The interest rate that you pay on the loan is fixed and is dictated by your credit score. The cost of financing is much lower for borrowers with high credit scores than for those with bad credit. Installment loans can be used to buy equipment or goods, for working capital or to consolidate debts, among other things.
Whether an installment loan is the best financing product for your business depends on why you need the money.
“You don’t want to take on debt for too long to provide a solution to a cash flow need that may be short,” said Josh Jones, director of revenue at Kapitus. “Knowing your needs is super important.”
What are the types of commercial installment loans?
Small business installment loans can be used to purchase a vehicle or business equipment, to acquire property, or to pay off expensive debt. They come in different terms, depending on the needs of your business.
- Long term loans: These loans have terms of six years or more. They are generally used for large purchases like a company vehicle or real estate.
- Medium term loans: These loans have terms of two to five years and are commonly used to purchase commercial equipment or to finance expansion.
- Short-term loan: These loans have a term of less than two years. They are typically used to purchase inventory, to fill gaps in cash flow, for working capital, or for other short-term cash needs.
The longer the term of the installment loan, the more interest you will pay and the harder it will be to get approved. Lenders take more risk when they commit to you for six years instead of 18 months, so they charge more.
“Whether you are using it for a vehicle, a piece of equipment, or a mortgage, be sure to use the money for something you bought during the repayment period,” Jones said. “If you don’t use the money during the repayment terms, an installment loan may not make sense.”
What do you need to apply for a business installment loan?
A small business installment loan is not as easy to obtain as other financing options. Banks, credit unions, and alternative lenders all offer installment loans, but expect a higher credit rating and more business strength than other types of financing. This is especially true during the COVID-19 pandemic, with lenders being even more risk-averse. This means that you will need a good credit rating, a solid business, and the willingness to provide collateral.
“If you have assets, equipment, real estate, or accounts receivable that you can use as collateral, an installment loan is right for you,” Meuse said. “There is more documentation required these days, sometimes a bit higher credit score and sometimes a loan to value ratio. [ratios] are less, but lenders have a good appetite. “
From your credit score to business bank statements, here’s what an installment loan application involves.
Credit score
Lenders are risk averse, so your chances of getting a low interest installment loan depend largely on your proven ability to repay it. This is where your business and personal credit score comes in. Unless your business has been in business for years and its income is growing steadily, lenders will look at your personal credit score to assess your creditworthiness. If your credit score is low, they will either deny your loan application or charge you a higher interest rate. Banks and credit unions generally have higher credit score requirements than other lenders. Some lenders cater to business owners with poor credit.
Collateral
Commercial installment loans are usually secured, which means you need to post collateral. Collateral can be an asset, such as equipment, accounts receivable, or property, that the lender gets if you don’t pay back the loan.
Personal guarantee
Unless you are running an established business with years of revenue growth, lenders will demand more than collateral; they will want a personal guarantee from you. This is a legally binding statement that you will repay the loan personally if your business is unsuccessful.
Business plan
In order to approve you for a loan, lenders will want to know about your business. This is where the business plan comes in. You want to have a compelling story, presented in a slideshow or in print, that shows your plans and paths for growth. It should be clear, concise, and detailed, showing lenders a solid business idea. The plan should include how much money you need and why, how you are going to repay the loan, and what assets you are willing to put as collateral.
Professional and personal documents
Lenders need a lot of documents about your business and your personal finances to approve your loan application. Banks and credit unions require more paperwork than other lenders, but in any case, it’s important to have everything ready before you apply. Each lender has their own version of the documentation, but these are the most common requirements:
- Bank statements
- Income tax returns
- Business plan
- Proof of business ownership
- Personal informations
Installment loans are a viable option for small business owners if they shop smart and choose the best lender for them. You don’t want to be stuck with a high interest loan and a lot of hidden fees. That’s why Libby Morris, vice president of operations at Funding Circle US, said it’s important to pay attention to all the costs associated with an installment loan.
“One of the things we look for in our responsible lending is whether they disclose all of their charges? Morris said. “Small business loans are not as regulated as consumer loans. You can see a good rate and there are all these hidden charges. Morris said to avoid lenders who charge you a prepayment penalty for prepaying your loan.
When applying for an installment loan, Morris said, be prepared for a counter-offer from your lender, especially in today’s environment. With the coronavirus still out of control, lenders are reluctant to take too much risk. They have an appetite for loans, but may not want to be as generous as you hope. Morris said it was no surprise that a business owner asked for $ 500,000 and got approved for $ 300,000.
“You have to be flexible about how much you really need,” she said.
