How Much is a Small Business Loan? Aspects to Consider
One of the first questions small business owners have when thinking about a loan is, “What will it cost me?” The answer depends largely on what kind of loan you get. There is quite a variety, so looking carefully at the details will pay off, said P. Simon Mahler, founder of BizSprout and a volunteer mentor with SCORE, a nonprofit association of business counselors.
“Look at what the different lenders are requiring you to pay back given the amount of money you are receiving,” Mahler advised. “Look at interest rates, terms and collateral interests the bank wants from you.”
And don’t limit your search to traditional banks, Mahler added. “Look at economic development committees in your community; a lot of times they have a grant in place for enhancement to a small business. Look at alternative lending for risky small businesses.”
If you’re getting a loan with an interest rate that isn’t fixed for the length of the loan, Steve Schillig, district director at the Ohio Small Business Development Center at Kent State University, recommends you ask about out factors such as when the interest rate will change and what the basis for the new interest rate will be.
How to determine how much a small business loan is
Read on for details of the costs and interest rates involved in different types of small business loans.
Look at the APR
A big factor in the price of your small business loan is the annual percentage rate or APR. This number includes the interest rate on the money you borrow plus any fees associated with your loan. When comparing loans, make sure you’re comparing APRs, rather than interest rates. An APR includes all the fees you’ll be charged for the loan — an interest rate does not include the fees.
APRs and interest rates can be either fixed, meaning they will stay the same rate for the length of the loan, or variable, meaning they could go up or down. The lender will base your rate on factors such as your credit history, how profitable your business is, how long it’s been around, how much you need to borrow and how long a term you want. It pays to shop around since rates can vary.
Consider the fees will you pay
You need to factor in fees when you think about how much a loan will cost. Here are some common fees you might have to pay for your small business loan:
- Closing costs. Similar to a mortgage on a house, a small business loan can involve closing costs. These can include expenses such as an appraisal of a property or a business you’re buying.
- Origination fee. This fee aims to cover the lender’s cost of processing the loan. The fee usually ranges from 1 percent to 4 percent of your total loan.
- Underwriting fee. This pays for underwriters, who examine the financial and business documents you’ve provided and determine whether or not to offer you the loan. The typical fee is 1 percent of the total value of your loan.
- Prepayment penalty. Some lenders will charge you extra for paying off the loan early. Be sure to check before signing on the dotted line.
- SBA guarantee fee. The popular 7(a) loans from the U.S. Small Business Administration have a fee on the guaranteed portion of the loan. For loans of $125,001 to $150,000, the fee is 2 percent; for $150,001 to $700,000 loans, the fee is 3 percent; and for loans of $700,001 or more, the fee is 3.5 percent (up to $1 million), plus 3.75 percent of the remaining guaranteed amount. There are no guaranty fees on loans of $125,000 or less.
Don’t forget that you might have to pay other fees, too, for things like making a late payment or not having enough money in your bank account to cover your payment.
Understand the costs of different types of loans
Traditional bank loans
These short- and long-term loans for set amounts come with fixed interest rates for fixed periods of time. They’re for small businesses in solid financial shape. Qualifying isn’t easy, but if you manage, you’ll get among the best rates out there.
Hypothetical example: You borrow $100,000 over five years to expand your business. Your interest rate is 8 percent and your fees total 2 percent of the loan. That makes your APR 10 percent. Your monthly payment would be approximately $2,125 and you’d pay a total of $127,482 for the loan over five years.
Lines of credit
These flexible sources of financing offer access to an immediate source of cash and can help business owners during an emergency or cash flow gap. The lender provides a specified amount of money for you to draw from, and the terms are either fixed or revolving. Maintenance fees (to manage the account) or draw fees (each time you take money from the business line of credit) might apply.
Hypothetical example: You have a $50,000 line of credit available, and you use $10,000 of it for one year to cover an unexpected expense. If your APR is 30 percent, you’d owe $975 a month to pay back the loan, and the loan would cost you a total of $11,700.
If you have a credit score of 600 or more, you might qualify for a personal loan you can use to fund your small business. If you own a home, you could use a home equity loan — which is like taking out another mortgage on your house — or home equity line of credit, which allows you to draw money from it as you need it. It’s easier to qualify for these loans than for traditional ones because you use your house as collateral — and you can access the money relatively quickly.
Hypothetical example: You take out a home equity loan for $50,000 at 5 percent APR with a term of 10 years. Your monthly payment would be approximately $530 and you’d pay a total of $63,639 over the life of the loan.
Rollovers for Business Startups (ROBS)
Not a traditional loan, this is a way to start or buy a business using money from your retirement account or accounts from a previous job. You don’t have to pay the money back to your retirement account, but you should have at least $50,000 in the account to make the rollover worth it. Keep in mind, however, that you might need another plan for funding your retirement.
Hypothetical example: You roll over $75,000 from a 401k held by a previous employer. After the setup costs, you have $70,000 to invest in a business, not including the monthly fee.
Banks and other lenders provide loans that the U.S. Small Business Administration guarantees. SBA loans are known for having long payment terms and low down payments. The most common SBA loan is the 7(a), and you can use it for a wide variety of business purposes.
Hypothetical example: You borrow $300,000 through an SBA 7(a) loan for 25 years at 7.5 percent APR to buy a new property for your business. You would pay approximately $2,217 a month, for a total of $665,100 over the life of the loan.
Online — or alternative — lenders tend to have higher interest rates and shorter repayment terms than bank loans, but they are easier to qualify for, especially if your business hasn’t been in existence for at least a year.
Hypothetical example: You borrow $10,000 at 20 percent interest for one year to buy inventory. You’d pay approximately $926 a month, for a total of $11,112 over the life of the loan.
More than 80 percent of U.S. businesses finance their equipment, according to U.S. Bank. Equipment loans provide money to buy or lease equipment — including vehicles — and sometimes you can repay them over the lifespan of the equipment you’re buying. Because the equipment serves as collateral, rates are relatively low (interest rates depend in part on the value of the equipment). Sometimes, you can finance multiple pieces of equipment with one loan application.
Hypothetical example: You borrow $15,000 for two years at 10 percent to buy a conveyor dishwasher for your restaurant. You’d pay approximately $692 a month, for a total of $16,608 over the life of the loan.
Invoice financing enables you to put your unpaid invoices to work by using them to secure a cash advance, which is usually equal to a percentage of the invoice, but not the full amount.
Hypothetical example: You sell your outstanding invoices worth $100,000 to a lender at 20 percent interest. The lender immediately pays you $85,000. When your customers pay their full outstanding invoices to the lender, you’ll receive $12,000 from the lender.
SBA disaster loans
These low-interest, long-term SBA-sponsored loans allow business owners to borrow up to $2 million to recover from a disaster. Repayment terms can range up to 30 years.
Hypothetical example: Your business is flooded, and some of the damage isn’t covered by your insurance. You borrow $30,000 over 20 years at 5 percent APR through an SBA disaster loan, using the building as collateral. You’ll pay approximately $198 a month, for a total of $47,520 over the life of the loan.
Merchant cash advance
A merchant cash advance, or MCA, involves a lender giving you money in exchange for a predetermined percentage of your weekly (sometimes daily) credit card sales.
Hypothetical example: You get a merchant cash advance of $10,000 to get your company through a rough period. Your factor rate is 1.5, so you’ll owe $15,000. You pay the lender 10 percent of your sales a day until you’ve repaid the $15,000. Better sales mean you’ll pay off the loan faster; slower sales means you’ll pay it off more slowly.
Business credit cards
Business credit cards function like a loan — you don’t pay interest as long as you pay off the full amount you owe every month. If you don’t pay it off, you’ll likely pay a high interest rate on the balance. Annual fees might also apply.
Hypothetical example: You pay for a new, $10,000 office printer with your business credit card, which comes with an 18 percent APR. You make the minimum payment of $300 each month. It would take 20 years to pay off the printer and would cost you a total of $19,421 over the loan.
The bottom line
Although the wide variety of loans that are available — and their associated costs — can seem confusing, remember that you’re looking for the same thing as you are when you buy any product or service for your company. You need something that will help your business grow and thrive — and that you can afford. So, when it comes to looking for a loan, do some comparison shopping. And make sure when it’s time to sign on the dotted line that you know the true cost of the loan, including interest rate, fees and charges.