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How to Get a Bank Loan for Your Small Business

Andrew Martins
Andrew Martins

Need funding? A small business bank loan can be a good option, if you qualify for it. Here are some tips to make it easier to get a bank business loan.

  • Understanding what your bank needs in the application process ahead of time can make the overall process easier to wade through.
  • Additional preparation, like having a business plan and your financials in order, can help ensure that you are approved for a business loan.
  • It is important to pick the right type of business loan for your specific needs since failing to do so will reduce your chances for approval.
  • This story is for any small business owner looking to obtain a business loan from a major bank as conveniently as possible.

Unless your small business is completely self-funded or backed by investors, you're likely going to need a small business loan to help you start or grow your business. Commonly offered by banks, business loans offer a much-needed infusion of cash to help cover most costs, though many small business owners find it hard to be approved. When looking to obtain a business loan from a bank, it's important to keep the following information and tips in mind so you can more quickly and easily get approved.

What to consider when choosing a business bank loan

Business loans from a traditional bank are some of the most sought-after forms of financing options for small businesses because of the safety nets inherently found in traditional banking. Backed by the federal government, banks, and most of their products, come with assurances that many nontraditional and online banking lessors don't. Also, bank loans generally carry lower interest rates than loans from online lenders.

As a small business owner, you have many options to choose from when it comes to the different types of business financing. Each type of loan comes with its own set of stipulations, requirements, and other criteria that may make one a better fit for your financial situation and repayment abilities than others.

After deciding that your small business would benefit from a business loan in the short term, it's important that you nail down exactly what type of loan you want to pursue. Failing to do so can result in lost time, sunk costs and other major headaches for any small business.

"One of the biggest mistakes that small business owners make when applying for a business loan is choosing the wrong kind of business financing," wrote Ben Shabat for Become.co. "It's best to investigate each kind of funding option ... before applying for a business loan, that way you don't waste time attempting to obtain a solution that might not actually address your financial problem."

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Common types of small business bank loans

When looking at potential financing options, here are some of the more common types of business loans to consider:

  • Business term loan: This loan is your traditional bank loan option, provided by a financial institution, and it operates similarly to a personal loan in some aspects. Businesses often seek this type of loan when they need funds for major investments, business upgrades, acquisitions or other major needs. Depending on the agreement, these loans tend to feature a fixed interest rate, with the lender requiring a monthly payment or quarterly payment schedule. These loans also have a fixed end date, with intermediate-term loans running for three years or less and long-term loans running for 10 years or possibly longer.

  • Line of credit: When considering a business line of credit, think of it like a credit card. If approved, your small business is able to borrow up to a certain amount of money from the bank. As you accrue debt, you only pay interest on the amount you've used so far. As long as you stay within that credit limit, this option provides much more flexibility in how the money is used. This option is great for small businesses that have a steady flow of income, a decent credit history, and in some cases, are willing to put assets up as collateral.

  • Commercial mortgage. If your business is looking to acquire a location to expand, a commercial mortgage is the type of loan you need. Commercial mortgages are secured through liens on a commercial property and act similarly to home mortgages. If your credit history is nonexistent or unflattering, a bank can require that the business owner or any principals personally guarantee the loan, promising to pick up the tab in the event the business goes under. While most residential mortgages typically last for 30 years, commercial mortgages are significantly shorter.

  • Equipment lease. Not unlike leasing a car, equipment leases spread out the cost of a major equipment purchase over a set amount of time. Most lessors don't need a large down payment on a lease, and once the lease has run its course, you can opt to either return the equipment or pay the rest of the equipment's value based on the life of the lease and the appreciation of the item in question. Though the monthly payments will be lower than the upfront cost of just purchasing a piece of equipment, it's important to note that interest will add to the price tag.

  • Letter of credit. A letter of credit is a guarantee from a bank that a seller will receive the correct payment owed on time. The guarantee comes in two different flavors: seller protection or buyer protection. In the former, the bank agrees to pay the seller if the buyer fails to make their payments and is generally offered for international transactions. Funds for this type of letter are sometimes collected from the buyer upfront in a sort of escrow. Buyer protection is offered in the form of a penalty to the seller, like a refund. Banks provide these letters to businesses that apply for one and have the credit history or collateral required.

  • Unsecured business loan. An unsecured business loan doesn't require the borrower to provide any collateral against the amount they're borrowing. Since it's friendlier to the borrower than the bank, the lender charges a significantly higher interest rate than it would for a loan backed by collateral. This kind of loan is most commonly provided through an online lender or other alternative lenders, though traditional banks have been known to offer unsecured loans to customers with an existing relationship with the institution. Without any assurances in the form of collateral, unsecured business loans are often much harder to obtain than other loans. The inherent risk involved in an unsecured loan naturally means it will generally be offered as a short-term loan to alleviate the lender's risk.

Alternatives to bank loans

Bank loans are not your only option. You can work with alternative lenders to secure the funding you need. Alternative lenders are an option to consider if your business doesn't qualify for a traditional loan. Here are two alternative lending options to consider:

  • Online loans: Online lenders are normally more flexible with loan qualifications, and the turnaround time is faster, but the rates may be higher than traditional loans. Lendio is one such online lender. You can submit an application through their secure interface. 

  • Microloans:  Microloans offer a small amount of money to help you cover certain costs within your company. Microloans usually have a relatively low interest rate. The disadvantages of microloans include a shorter time frame to pay back the loan, and some lenders require that the money from the microloan be spent on specific expenses like equipment purchases.

Terms to watch for in a business loan contract

Besides the type of loan you apply for, consider the details of the loan. Each loan comes with its own interest rate and loan term, among other points of consideration that are as equally important as the type of loan you take on. It's important to read the contract in full to make sure there aren't hidden terms or fees.

When applying for a bank loan, check the following:

  • Rates: Aside from the amount of money you wish to borrow, the loan rate – otherwise known as the interest rate – is something you absolutely must determine. Loan rates differ based on the type of loan you're seeking, the bank you're borrowing the funds from and your personal credit score, among other things. When seeking out a business loan, you want one with a low interest rate, if possible. Depending on the type of loan, you may see rates range anywhere from 3% up to 80% annual percentage rate. 

  • Term: A business loan's term is the length of time you have to pay the loan off. Like the loan rate, you generally want a shorter loan term if you can afford the payments. The longer your rate is, the more interest you will pay over time and the more your loan will cost overall.

  • Banking relationship: To be considered for a bank business loan, many institutions require that you have an existing relationship with them first. If this is not the case, you'll need to open an account with a bank and establish a working relationship with it over time.

Key takeaway: Carefully consider the type of loan your business will need, along with the type of agreement you will have to enter once approved.

What do banks look for in a business loan application?

When applying for a business loan, it's imperative that you keep a bank's requirements in mind. Each bank has its own loan application forms. Many institutions offer their applications online, though some still require you to fill out a paper form. Based on the loan amount and the kind of loan you're seeking, the bank may have a preferred method of applying.

In addition to how a bank prefers to receive a loan application, you should also consider the prerequisites that a bank needs in order to be considered for approval. There are many factors that go into a potential approval, so prior to applying, be sure to check on the following:

  • Credit score: A high credit score shows that you're reliable when it comes to paying down your debt. A good credit score not only can make or break your application, but it also impacts the interest rate and loan term length the bank offers you.

  • Purpose of the loan: Some loans come with stipulations for how they're used. For instance, a lease is generally used to obtain equipment, while a mortgage is for real estate purchases.

  • Available collateral: If your credit score isn't good enough, some lenders will make an exception if you can put some valuable items (usually property) up as collateral. If you fail to meet the agreement's repayment guidelines, you can lose that collateral to the bank, which will likely sell the assets in question to recoup some of its losses.

  • Cash flow: Banks want to know you have a steady stream of income. Without a consistent cash flow, traditional lenders could be skittish about approving your loan. Many lenders require a certain amount of revenue before even making such a consideration.

  • Financials: Cash flow history is one type of document that the bank will want to see prior to approving a loan. You will also need to show well-researched financial projections for your business. 

  • Business plan: Any type of lender can ask for your business plan before reviewing an application.  There are many resources available to help you get started on writing an effective business plan for your organization.

  • Capital: Working capital refers to how much money the company has on hand to cover operating costs. If you don't have any working capital, you may be considered a high-risk investment.

Key takeaway: Only you know your business's financial situation. By gathering the appropriate information, you can assuage a lender's concerns about your business's ability to repay financing.

Get ready to apply for a business loan

Once you've found the right loan for your needs and considered what your bank will need from you, you will need to apply for the loan. Keeping the following three tips in mind will make the application process smoother, since you will already have the information available when asked by the potential lender.

  1. Get your financials in order. According to one professional, an applicant should have their financials ready to go. To do this, ask the bank what information they will need when going through the application process relative to the type of loan you're seeking and the size of the request. To this end, you should generally try to have three years' worth of business and personal tax returns on hand as well as year-to-date profit and loss figures, balance sheets, accounts receivable aging reports, and inventory breakdowns if possible. If you have a CPA or bookkeeper, you can usually get all of that information from them, though accounting software like QuickBooks or Quicken can just as easily generate most of that information as well.

  2. Create a business plan. If you're seeking a loan as a startup, it's imperative that you also have your business plan drawn up. If you don't have that laid out in writing just yet, there are plenty of free resources that you can use, including local Small Business Development CentersSCORE and Economic Development Centers.

  3. Estimate how much you're going to need. If you need a loan for a one-time purchase or another financing option, it's also important to have estimates for the work or purchase ready to show the loan officer.

"Lenders want to see that you've carefully thought through your business goals, know how much you need to achieve them and have a specific plan to use the money wisely," said Karen Axelton, writing for Experian. "Whether your goal is to open a second location or buy new machinery, run the numbers to see how much it will cost. Also calculate how loan repayments will affect your business budget going forward."

Key takeaway: For a smoother lending process, prepare your financial information and business plan in advance so it's ready to go when you meet with your bank.

Image Credit: fizkes / Getty Images
Andrew Martins
Andrew Martins,
Business News Daily Writer
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I am a former newspaper editor who has transitioned to strictly cover the business world for business.com and Business News Daily. I am a four-time New Jersey Press Award winner and prior to joining my current team, I was the editor of six weekly newspapers that covered multiple counties in the state.