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Updated: Oct 21, 2016
Shopping for a small business loan is a lot like trick-or-treating — everywhere you turn there are friendly people offering you a sweet deal.
You may be tempted to rush into a loan agreement from the first lender you visit, but experienced trick-or-treaters know that with this mentality you’ll likely wind up with a bag full of Tootsie Rolls and Good & Plenty. If you’re lucky, you can trade up for a king-sized Snickers at the end of the night, but a loan with unfavorable terms can haunt a company’s financials for years to come.
Here are three simple steps you should take to keep your entrepreneurial dream from veering off Main Street and onto Elm Street:
Halloween has plenty of gore and guts to go around, but when it comes to business financing, it can be easy to forget to use your own. Check your gut and trust your instincts when you find a deal that sounds too good to be true. For example, if the offer is only around for a few hours or days, there may be a reason.
This is an important financial decision and opportunity that will affect you and your business for years to come, so you should never feel rushed into a deal without being able to ask a real person all of your questions. One of the most important questions to ask: what happens if I pay my loan back early? Some lenders may charge you a fee, or require that you still pay the full amount of interest even though you’re borrowing the money for a shorter period of time. Personally, we think you should only pay for the time you borrow!
The last thing you want is to partner with a lender who cares more about their bottom line than yours, so it’s important to look for a lender that understands your business and actually cares about helping it grow.
You may not believe in vampires, but there are some short-term, high interest financing options that have the potential to suck the revenue right out of a business. For example, while merchant cash advances (MCAs) may be fast and easily accessible, their advertised rates may appear lower than what they really are and can be tricky to compare directly with other financing products. To combat this, it’s important to calculate an annualized percentage rate, or APR.
APR is a measurement that combines the quoted interest rate with any additional fees, and spreads it out over a standard amount of time — one year — to tell you the true cost of the loan. It’s the best way to get an apples-to-apples comparison between different loan offers. Nav, which provides business owners with simple tools to build strong business credit, has some great calculators to help businesses compare the true cost of borrowing across different types of loans.
Before jumping head-first into an offer that sounds too good to be true, you might find that by shedding some daylight on those compounding rates and sweeping the fine print cobwebs off the hidden fees, you’re really looking at an APR of 50-100%! Even if your business can’t qualify for a bank loan (with APRs in the single digits), there are lots of alternatives with APRs in the low teens you might consider first. Keep Dracula away from your bottom line by shedding some light on the true cost of your loan. Learn how to calculate your own APR.
A loan should improve your business’ cash flow situation, not complicate or cripple it. When reviewing your loan offers, remember to ask how much you’ll pay each month and when your first payment will be due.
It may sound convenient, for example, to have your MCA repayment schedule tied to your daily revenue, but short-term cash advances with high APRs can seriously affect your bottom line — especially if you’re in an industry with margins below 10%. Depending on short-term financing to cover your long-term business needs isn’t sustainable. When you’re borrowing money to grow, the last thing you want to do is get caught in a downward debt spiral, borrowing more and more debt to roll over repayment obligations.
Some business owners prefer to use a credit card to fund big purchases. While this can be a good short term financing option, if you’re not able the pay off the full balance every month, the effective rates can send shivers down your spine. Credit cards also often come with variable APRs, which means the amount you owe may suddenly change.Read more:Three reasons why you shouldn’t fund your business with credit cards
In contrast with these two options, a term loan may help you avoid any spooky surprises while planning your business’ budget. Fixed, monthly payments allow you to plan and budget well in advance, and a longer term product means your monthly payments are smaller — allowing you to really invest the money in projects that will help your business grow.
If you’ve been trick-or-treated into a financial product with scary interest rates, it’s not too late. Refinancing business debt is one of the best ways to clear the skeletons out of your closet and set your business on a new path for growth. Discover four ways refinancing debt can help your business.
Read this next: 4 financing rights of every small business owner
Paige Smith is a Content Marketing Writer and Senior Contributing Writer at Funding Circle. She has a bachelor's degree in English Literature from Cal Poly San Luis Obispo, and specializes in writing about the intersection of business, finance, and tech. Paige has written for a number of B2B industry leaders, including fintech companies, small business lenders, and business credit resource sites.