Understanding different business loan structures, eligibility requirements and total costs may help you narrow down the right lending product, budget confidently and reach your business goals. Let’s explore how small business loans work, review common eligibility criteria and how to complete the application process.
What is a small business loan?
A small business loan is money that you borrow for business expenses and repay over time, along with any interest and fees. The repayment period may range from 6 months to 20 years or longer, and the funds can be used to pay for inventory, essential equipment, work vehicles and even real estate.
Business loan terms, rates, repayment structures and collateral requirements vary, so understanding how these loans work on a case-by-case basis can help you find the right one for your business.
How do small business loans work?
Some small business loans may require collateral, such as the equipment or real estate you’re financing, or a personal guarantee that makes the owner responsible for paying if the business defaults. Loans also have a principal, or the amount of money that you apply for and receive.
Upon receiving funds, you start making set payments over a pre-established period, sometimes following an amortization schedule that applies early payments mostly toward interest, while later payments cover more of the principal. Payment frequency – whether monthly or weekly – and duration depend on the lender, who may allow you to pay off your debt early. But remember that the principal and interest aren’t the only amounts you may be responsible for.
Loans also typically have an interest rate, at a fixed or variable rate, plus any potential borrowing fees like:
- Origination fees that cover the cost of loan processing and underwriting, or assessing lending risk
- Closing fees, which you may have to pay when signing the final paperwork for the loan
- Early payment or prepayment penalty fees, which may arise if you pay your loan off early
Understanding how these loans work may help you choose the right type of loan for your business needs.
Common types of small business loans
Small business loans can come in several forms, each with its own structure:
- Term loans: Provide a lump sum, typically for large one-time expenses, and later repaid on a fixed schedule
- Small Business Administration (SBA) loans: At least partially backed by the government, typically offering lower rates and longer repayment terms when you’re eligible
- Commercial real estate loans: Long-term loans that work like mortgages, using a business’ brick-and-mortar location as collateral when it needs to purchase or lease real estate
Once you’ve chosen the best loan type for your business, you can begin working toward meeting eligibility requirements.
Common requirements for a business loan
To determine if your business is eligible, lenders usually consider several factors, such as your personal credit standing and, if applicable, your business credit profile.
Other eligibility requirements may include:
- The length of time you’ve been operating, with many lenders preferring businesses to operate for at least 2 years before applying. If you don’t meet this threshold, an SBA loan might be right for your business.
- Your business’ annual revenue
- A business plan or loan proposal, complete with a financial timeline for your goals, repayments and profit projections
- Documents like tax records, bank statements, employee identification number (EIN), business insurance, proof of ownership and more
