As the new year approaches, you probably have some big goals or plans for your small business. Chances are that those goals require money, money that you may not have on hand.
This may mean it’s time to look into financing. To many business owners, debt is certainly a four-letter word and something to avoid, but a well-chosen path of financing can make all the difference.
If you’ve been denied in the past because of a low business credit score, don’t give up. Shopping for different types of lenders may be the answer.
Two of the most popular—and cheapest—financing options are loans and lines of credit. Both will get cash in your pocket, but they work a lot differently.
Business Loan or Line of Credit?
The Basics: How they work
A business loan is fairly simple to understand. Your lender gives you a specific amount of money all at once. That amount, plus interest, is repaid in pre-arranged monthly installments.
You’ll usually have from 1 – 15 years to pay it back. Loans can carry closing costs of 2% – 7%.
The loan concept is easy, but the application and paperwork can be confusing. If you’d like some help, here’s a free guide and checklist.
A business line of credit gives you the option of borrowing just the amount you need, up to a pre-arranged maximum amount. Think of it like a credit card.
You only pay interest on the outstanding balance, not on any unused portion. Credit lines have minimal or no closing costs.
What’s best for your situation?
Normally, you wouldn’t take out a loan unless you have specific long-term purpose for the cash—usually to help fuel growth. May be you want to:
Add vehicles to your fleet
Buy more efficient equipment
Hire more employees
You should know exactly how using the loan will boost your revenues. Your lender will want to see the forecasts.
Lines of credit, however, are best for short-term purposes such as financing receivables, marketing, and making payroll.
They can be invaluable for unexpected cash-flow issues, but be careful! Don’t max it out on “surprises.”
While it’s reassuring to have access to working capital, you should still be using as much of it as possible for activities that generate revenue.
Paying back the money
Yes, unfortunately, you have to pay these things back.
Because loans carry fixed terms, monthly payments are usually higher than the payments on a credit line.
For example, the monthly payment on a $50,000 loan can be up to $700 more than if you owed $50,000 on a line of credit.
Although, the interest rate on a loan is usually locked in, so it won’t change. This can make it easier to plan for.
On the flip side, the rate on a credit line will usually vary, based on the prime rate. This can be trouble if rates surge higher, but it also has an added benefit:
If you manage your business credit well, your credit scores will improve. That means you can negotiate lower rates or a higher credit limit as they do.
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Which one is easier to get?
Typically, it’s easier to qualify for a loan because the money is secured by collateral—usually the equipment or building you’re using the money to purchase.
If you don’t pay back the money, the bank takes your stuff. Sometimes the required collateral can be worth twice as much as the loan itself!
Although credit is loosening, banks are still hesitant to take on much risk. Don’t be afraid to interview multiple lenders and negotiate for lower collateral requirements.
You may find that smaller community banks are more willing to bet on your business than big banks, especially if you have an existing relationship.
Collateral may also be required for a line of credit, but not always. Either way, it carries more risk for the lender because you have discretion on how the funds are used. What you purchase may not result in sufficient collateral to secure the amount you owe.
Generally, a strong business credit rating and solid financial history are required to get an unsecured line of credit. Few lenders will approve these for young start-ups.
Make a plan and execute
Few businesses are able to grow without financing help. With a new year approaching and goals to be met, now is the time to set yourself up for success.
A necessary part of preparing for a loan application is to stay on top of your business credit scores. You can check yours for free with Nav to know where you stand and make the process as pain-free as possible.