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Updated: Feb 6, 2020
When you need working capital to launch a new business or expand an existing one, a term loan can be an ideal solution. Term loans feature better interest rates than other lending options, such as a credit card or merchant cash advance, along with flexible repayment terms.
Applying for a term loan is a fairly straightforward process but there are several factors that influence your ability to get funding. We’ve created a quick checklist highlighting what small business owners can do to increase their chances of being approved.
Term loans aren’t one-size-fits-all and it’s important to understand what your financing options are. For example, if you only need to borrow a small amount that you’ll be able to pay back relatively quickly, a short-term loan may be the right choice.
On the other hand, a long-term loan is better suited to businesses who need to borrow larger amounts and take longer to pay it back. Bond Street also offers a third borrowing avenue in the form of an intermediate loan, which features a repayment term of 1 to 3 years.
Aside from the loan length, you also need to decide whether you want to pursue a collateralized or uncollateralized loan. Generally, the higher the loan amount and the longer the repayment term, the more likely the lender is to require some form of collateral.
Term loan lenders consider various aspects of your business and personal finances, including your credit scores. Business credit scores are generated by a number of agencies, with Dun & Bradstreet being the most common. For personal credit, term loan lenders typically consider your FICO and Vantage scores.
The minimum personal and business credit scores you’ll need to qualify for a loan vary from lender to lender. At Bond Street, for example, we prefer applicants to have a personal credit score of at least 660 but some banks may offer financing with a score as low as 620.
Scan your personal credit report for any errors or inaccuracies that may be hurting your score. If necessary, initiate a dispute with the credit reporting bureau to have the information corrected or removed. This is particularly important if you haven’t established a separate business credit history yet.
While your personal and business credit history is an important factor, it’s not the only thing lenders consider when making term loan approval decisions. Any or all of the following may also come into play:
Understanding what each lender’s preferences are can steer you towards the one that’s positioned to offer you the financing you need. For example, if you only recently launched, you wouldn’t want to waste time approaching a lender that requires at least two years of operating history.
Cost is one of the most important considerations when applying for a term loan. As you’re vetting potential lenders, pay close attention to the interest rates they’re offering. Rates can go as low as 6% or as high as 30% and your rate directly impacts the cost of borrowing over the long term.
For instance, let’s say you own a small cafe and you want to borrow $100,000 to upgrade your kitchen equipment. Lender A is offering you a five-year term at 10% while Lender B is offering a seven-year term at 8%. The payments for the first loan would come to just over $2100 a month while the second loan would have a payment of around $1560.
From a cash flow perspective, Loan B seems like the better option because it frees up roughly $600 a month you can put back into the business. The fact that the rate is lower also looks good on paper. When you do the math, however, you end up paying $3,500 more in interest over the life of the loan. Weighing the total cost against any short-term benefit can help you choose the right loan for your bottom line.
Understanding the ins and outs of terms loans is a must when you’re ready to grow your business. For a more detailed look at what term loans involve, take a look at our in-depth review of this valuable financing tool.
Michael Jones is a Senior Editor for Funding Circle, specializing in small business loans. He holds a degree in International Business and Economics from Boston University's Questrom School of Business. Prior to Funding Circle, Michael was the Head of Content for Bond Street, a venture-backed FinTech company specializing in small business loans. He has written extensively about small business loans, entrepreneurship, and marketing.