If you want to start or grow a business but don’t have sufficient funds, a conventional business loan is a common source of funding. These loans are often found in financial institutions, such as traditional banks.
For younger businesses with less credit history or who do not qualify for conventional loans, Small Business Administration (SBA) loans are a good choice. Here’s how to choose whether an SBA loan or a conventional business loan is right for your business.
What is the difference between an SBA loan and a traditional business loan?
Two of the main differences between a conventional business loan and an SBA loan is that an SBA loan generally has a longer term and a lower interest rate than a conventional loan.
SBA loans and conventional business loans are usually issued by banks. SBA loans, however, come from banks that participate in the SBA loan guarantee program. The program promises that the SBA will buy back part of your loan from the lender if your business goes bankrupt and you don’t repay the loan. An SBA guarantee typically ranges from 50 to 90% of the loan amount up to $ 5 million, depending on the loan program.
What is an SBA loan?
The SBA is a government agency that partners with SBA-approved private lenders to provide a variety of loans to businesses that cannot get conventional loans. Depending on the type of loan you get, the SBA eliminates a percentage of the risk that banks take when financing start-ups.
One SBA loan option is the 7 (a) loan program. As the SBA’s most popular loan program, 7 (a) helps businesses finance start-up costs, purchase equipment and inventory, buy or expand existing businesses, or secure funds. bearing.
Who is better for: SBA loans are best for new businesses that are in the United States and have not been in business long enough to build a strong credit history.
Requirements for an SBA loan
To qualify for an SBA loan, the business must generate profit in the United States and the owner must have equity involved. SBA loans also have eligibility requirements that businesses must meet in addition to own criteria. underwriting of lenders.
Additionally, businesses must meet the program’s size standards for small businesses and are only eligible if they are not otherwise eligible for conventional loans.
Key Considerations of an SBA Loan
- Offers small and large loan amounts. The SBA’s Small 7 (a) Loan offers business loans of up to $ 350,000, while the Standard 7 (a) Loan offers financing of up to $ 5 million.
- Longer loan terms. SBA loans have repayment terms of up to 25 years, which could make monthly payments more manageable. Conventional loans generally have terms of up to 10 years.
- An option for businesses with no credit or bad credit. SBA loans were designed for small businesses that would not qualify for a conventional loan from a bank.
- You must meet the requirements of the SBA and the lender. The application process and approval can take longer, and businesses must meet the eligibility criteria of the lender and the SBA.
How to apply for an SBA loan
The first step in applying for an SBA loan is to visit SBA.gov and complete the SBA Lender Match form. The form takes about five minutes to complete and asks applicants to describe their businesses and needs.
Within two days, the applicant will receive an email with a list of lenders they have been matched with. The business can then contact private lenders individually to compare rates, terms, and other details before making a decision. Once a business has chosen which SBA-approved lender they want to go ahead with, they will submit an application directly to the lender.
What is a classic business loan?
Conventional loans are usually offered by banks, credit unions, and other financial institutions. In some ways, they work like personal loans in that lenders provide approved businesses with lump sum financing and businesses repay the loans (plus applicable interest and fees) over an agreed term.
Depending on your loan agreement, a business loan can be used to expand your business, purchase business-related equipment, or consolidate business debt, or as working capital.
Unlike SBA loans, the bank assumes 100% of the risk if your business fails. Since conventional business loans have high stakes for private lenders, banks often require borrowers to have good credit.
Who is better for: A business that has been in business for many years with a positive financial record has the most to gain from a conventional business loan. If you and your business have high credit scores, private lenders may be more inclined to offer competitive interest rates. Low rates save you money on the cost of borrowing, and fixed rates give you predictable monthly payments.
Requirements of a classic business loan
A business looking for a conventional loan will need to demonstrate its ability to repay the loan. This includes providing the lender with a business plan that outlines its details and financial projections.
Financial institutions also require a good business credit rating, as well as a strong personal credit rating from the person representing the business. Businesses should also have a low debt ratio.
Key Considerations of a Conventional Business Loan
- Requires strong professional and personal credit scores. Since the lender absorbs all the risk if a business goes bankrupt and defaults on the loan, they will usually need strong credit scores to qualify.
- Can offer competitive rates. Since approval is highly credit-dependent, some conventional loans offer lower interest rates for businesses with high credit scores.
- Difficult for borrowers without credit or with bad credit. Start-ups with no established credit or those with bad credit may have difficulty getting approved. If approved, conventional loan rates are likely to be high.
- Variety of loans available. Private lenders offer conventional business loans in varying amounts and with different payment terms and schedules.
- The approval process is generally faster. Lender approval is based on the bank’s underwriting criteria, which means less paperwork and less time required to make a decision.
How to apply for a classic business loan
A business can apply for a conventional loan directly from a preferred lender. Many lenders accept applications in person at branches, over the phone and online in a convenient manner.
Loan review and approval times vary from bank to bank.
SBA loan vs conventional loan: which is better?
If you are at the beginning of your research and are considering an SBA loan over a conventional loan for your small business, you will want to explore both options before making a final decision.
Consider the stage of your business (for example, a start-up vs. an established business) and its credit history and financial outlook to help you determine which option is best. Also, when you compare lenders, calculate the cost of a business loan to see which one is the most affordable.
Keep in mind that just as no two conventional lenders are the same, neither are SBA lenders. And since you will need to exhaust your financing options to be eligible for SBA loans, exploring conventional business loans can be a useful first step. Whichever direction you take, it’s a good idea to shop around and choose a lender who understands your business goals and needs.