Business Loans & Funding

How business loans work

Updated: 24 September 2020

Business loans can be a fantastic way to get extra funding. They could help you grow, boost cash flow, hire staff and much more. However, as with any financial decision, it’s important to understand how they work and what to look out for. In our guide below we answer the key questions to help you understand how business loans work.

What is a business loan?

A business loan is an agreement between your business and a lender. They agree to give you an amount of money, and you agree to pay them back. It could be for something specific like buying a piece of equipment, or for more general use like extra working capital.

The lender will charge you interest, which you’ll pay back along with the amount you borrowed. Typically you’ll pay back in monthly instalments, although this can vary with some types of loan.

What types of business loan are there?

There are a variety of business loans out there for different needs and circumstances. There are two main categories:

  • Unsecured business loan – Take out a loan without using business assets as a security. Available for a wide range of purposes, they’re helpful if you don’t have valuable assets to use, or if you have borrowed against them already. You will often have to provide a personal guarantee instead.
  • Secured business loan – A loan where you use assets as a security. That means that if you’re unable to repay, the lender can take the assets instead to cover their loss. Secured loans are useful if you want to borrow a large amount.

Learn more about secured and unsecured loans, and what is a personal guarantee.

There are many other types of loan or credit that fall under these categories, including invoice financing, asset finance, merchant cash advance, and credit cards. The right loan for you depends on your circumstances, but you can learn more about them in our blog.

What is the cost of a business loan?

Typically, a lender will charge you interest and fees. Fees can vary greatly from one lender to another, so it’s important to find out what you’re being charged for. You can expect to pay an arrangement or completion fee when you take out the loan. There may also be servicing or renewal fees, or early repayment fees.

Your interest rate will usually depend on your loan term and credit assessment. If you pay back your loan quicker, you’ll pay less interest, but your monthly repayments will be higher.

At Funding Circle you pay only a one-off completion fee when you take out your loan, and our interest rates start at 1.9% per year.

How do you apply for a business loan?

Each lender will have a different application process. Some require meetings and paper forms, others can be done online. However, while ease and speed may vary, there will be some common ground between all of them. Here are the typical stages:

  • Check if you’re eligible – Each lender will have a set of lending criteria. Your business may need to be a certain age or have a certain turnover.
  • Fill out an application form – This may be online or hard copy. You’ll need to put down details of your business and what you want the loan for.
  • Provide supporting documents – Most lenders will ask for documents such as bank statements and accounts to assess your ability to pay back the loan.
  • Credit checks & assessment – With the information you’ve provided, the lender will run a credit check on your business. They’ll then decide if you can afford the loan.
  • Make you an offer – If they think you can afford it, and you meet any other criteria they have, they’ll make you an offer. This will state the loan amount, interest rate and your monthly repayments.
  • Accept and receive funds – If you’re happy with the offer, you can accept it and the lender will transfer the money to your bank account.

To find out more about how to apply, read our blog Credit checks – get in shape for approval.

How quickly can you repay your business loan?

When you take out your business loan, you can usually choose your repayment term. Some providers will only do short term loans, but lenders such as Funding Circle go up to 5 years.

You may also be able to pay off your loan early. This can be very handy if you get ahead, as it will save you money paying interest. Depending on your lender there maybe a charge for this, although Funding Circle has no fees for full early repayment.

What is a peer-to-peer or direct lending?

Loans from lending platforms such as Funding Circle are known as direct lending, and often called peer-to-peer (P2P) loans. They work exactly like a normal business loan, the only difference is the way they are funded. If you get a business loan from a bank, the bank will lend you their own funds. This doesn’t happen with Funding Circle.

Instead, the loan can be funded by lots of individuals all lending small amounts. They each lend money to your business, then earn interest as you pay the loan back. Alternatively, it may also be funded by a single organisation like a local council. You never speak or deal with them directly, but you have the knowledge that there’s a community of thousands of people backing you and your business.

If you’re looking to get funding for your business, you can check your eligibility for a business loan in 30 seconds.

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