Alternative Lending: When is it a Right Fit for You, and When is it Not?

Alternative Lending: When is it a Right Fit for You, and When is it Not?

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You don’t have to walk into your local bank to a get a small-business loan these days. Alternative lending options are just a few computer keystrokes away.

And they’re becoming more popular.

Online lenders, which offer the most common forms of alternative lending, approved 71% of the loan applications they received from small-business borrowers last year, according to a 2015 survey by a group of Federal Reserve banks. That’s the second-highest rate after small banks, which approved 76%, and much higher than the 58% approved by big banks.

But alternative business loans can be complicated and confusing, even risky. They’re not for everyone.

In fact, only 15% of small-business borrowers in the Federal Reserve survey said they were satisfied with their experience with online lenders, the lowest rate among financial institutions in the report. (That compares to 75% for small banks, 56% for credit unions and 51% for large banks.) The top reasons for dissatisfaction given were high interest rates, unfavorable repayment terms and a lack of transparency.

So when is alternative lending good — or not so well — for your business?

Alternative lending is good when you can’t get a bank loan
Alternative lending took off in the wake of the 2008 financial crisis, when banks pulled back dramatically from issuing small-business loans. Online lenders stepped in to fill the void, creating Web-based platforms that could quickly process loan applications, providing relief for small-business owners turned away by banks.

Technology was a key factor in this development, as it allowed new players to swiftly evaluate the creditworthiness of borrowers. Online lenders use different types of data — bank statements, tax returns, online accounting sites and even social media accounts — to analyze potential borrowers’ personal and business finances.

There are four main kinds of alternative or online financing:

  • A term loan is a lump sum you borrow and repay in about four or five years based on set terms, including the annual percentage rate. This is generally the least expensive type of financing.
  • A line of credit gives you access to a set amount of cash that you tap when necessary. This is generally used by businesses that need short-term financing to bridge cash-flow gaps.
  • Invoice factoring, also known as invoice financing or accounts receivable financing, is an option for small businesses that deal with unpaid invoices. Instead of just waiting to be paid, you can get an advance on those invoices, which you then pay back along with a fee when your customers settle their accounts.
  • Merchant cash advances offer a way to get an advance on future credit card or debit card sales. They’re easy to get, but think twice about applying because merchant cash advances are typically very expensive. The APR can range from 70% to 350%.

Banks still offer the best deals, especially federally guaranteed SBA loans. But those are usually tough to get, and you have to deal with stringent requirements and a long wait.

Alternative lending is good when you need quick cash
Alternative lending offers a way to deal with a pressing business need or an emergency. If your plumbing goes out or you suddenly run out of supplies, you can’t really wait weeks, or even days, to fix the problem. Quick access to capital helps you deal with the problem immediately.

With bank loans, especially financing backed by the Small Business Administration, you have to submit a long list of documents, including any business leases and a detailed financial history. In contrast, many online lenders require fewer documents. And for many online lenders, the main focus is whether you have the cash flow to make the payments.

In addition, you can get funds from alternative lenders within days, even a few hours, and the requirements are typically easier to meet.

Alternative lenders also provide longer-term loans to invest in growth, such as opening a new store or hiring more workers. Of course, as noted, in exchange for quicker and easier access, your borrowing costs are likely to be higher.

Alternative lending isn’t good when you get stuck with high APR, steep payments
Getting quick and easy financing has a price. Online lenders generally charge a higher APR, which is the true cost of the loan, including all fees.

A few online lenders offer APRs in the single digits, but you need excellent personal credit and a profitable business to qualify for them.

Most alternative business lenders offer loans with double-digit, even triple-digit, rates.

That’s because most online lenders get their funding from capital markets, so their lending costs are higher than those of banks. And lenders are taking on higher risk to extend credit to borrowers who are likely to be rejected by traditional banks.

Most online lenders also require shorter loan terms, which mean higher regular payments.

Evaluate small-business loans carefully
Alternative lending has multiple upsides — among them, speed, convenience and looser requirements. But it’s essential to compare loans by APR and make sure you can handle the required payments.

Why Traditional Banks are No Longer Lending to Small Businesses

Why Traditional Banks are No Longer Lending to Small Businesses

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Remember the days when you’d need funding to start or grow your business, and you’d get in your car and head down to the bank on the corner?

You knew your banker personally, perhaps even had kids in the same class at school, or would often see them at your favorite local restaurant. This personal relationship helped fuel a strong financial relationship; you knew exactly where to go to get the loan you needed.

But, the days of driving to your local bank for a business loan are long gone. Not only are community banks getting eaten up by the big banks, but bank lending to small businesses is at an abysmal rate. If you’re a small business owner, and you walk into a bank, you’ve got around an 80% chance of getting denied. Yep. That’s right.

Instead of sitting here, drowning in these depressing statistics, let’s take a look at why this drop in small business bank lending is happening.
 

Why lending to small businesses is declining

When small business lending took a hit during the recession, most thought it was purely a victim of the economic downturn and would eventually inch its way back up.

However, that hasn’t been the case. The total dollar volume of bank loans to SMBs has declined by 20% since the start of the recession. And, it just continues to trend down. Here is why:

  1. Increased regulation. Post-recession, banks have had to tighten up their standards and be extra-cautious about the risk in their portfolios. Remember, they are making these loans with my money, your money, and your neighbor’s money. Hence the reason they have to be so cautious. Unfortunately, small businesses are inherently riskier than their larger counterparts, which makes banks think twice before extending them credit.
  2. Downturn in community banking. Small businesses have historically had more success finding a loan at a community bank than a big bank. In fact, community banks have 3 times the approval rates on small business loans than the big banks. But, our number of community banks have been declining since the 1980’s, inadvertently hurting America’s job creators. With fewer community banks, there is less opportunity for business owners to find a loan at a traditional banking institution.
  3. Less profit on smaller loans. More often than not, small business owners are looking for smaller loan amounts. In fact, our average loan size at Premier Business Lending is $50,000. Other data shows that about 80% of small businesses want loans that are less than $500,000. But, it doesn’t make financial sense for banks to provide these smaller loans. Why? It costs banks just as much to underwrite a $1 million dollar loan as it does a $100,000 loan. Therefore, they can make way more money focusing on larger loans. At the end of the day, banks are businesses too.

When you stop and look at the reasons banks have cut their lending to small businesses, it makes sense. But, it is still frustrating that business owners are having to face so much rejection. That being said, small business owners need to learn to approach their loan search differently. It’s no longer about expecting the banks to give you credit; it’s about being aware of multiple ways to fund your business and preparing to try a few different sources.

But, what are other sources of funding outside the bank?

Meet “alternative” lending. Online lenders have started emerging over the years to help fund borrowers that can’t find capital at the bank, and given the decline in bank lending to small businesses, the alternative lending industry is booming.

Alternative lenders are simply any non-bank lender. These lenders can most often be found online, as they don’t have physical storefronts like the banks. They include well-known companies like Can Capital and Premier Business Lending, as well as hundreds of lesser-known companies. These alternative lenders are offering traditional term loans, invoice financing, short term loans, and more.

So, as you can see, there is hope. As these online lenders mature and their underwriting algorithms get smarter, online lending could very well become the “norm” and end up being able to compete with banks on price.

9 Regulatory Changes That Could Affect Your Business This Year

9 Regulatory Changes That Could Affect Your Business This Year

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With another year, comes another set of laws and regulatory issues that businesses need to be aware of.

In 2016, many issues affecting the regulatory landscape revolve around employee pay. Changes to overtime rules and paid sick leave, as well as increased minimum wages are all issues businesses need to stay on top of this year.

Business owners have been inundated with proposed regulations that will affect how they pay employees in 2016.

To help businesses deal with these changes, Premier Business Lending has identified nine regulatory issues that should be on small businesses’ radar in 2016:
 

1) Overtime regulations: In 2015, the U.S. Department of Labor proposed new salary thresholds for white-collar workers. The proposal would raise the salary threshold from $455 a week to about $970 a week in 2016.

After hearing input from the public on the proposed increases, the agency is expected to release its final ruling this spring. Employers will need to be prepared to take immediate action in order to comply when that ruling is unveiled.
 

2) Employee pay: Employers throughout the country will be adapting to minimum wage increases, as well as new laws on equal pay and paid sick time in 2016. Specifically, there is a new industry-specific minimum wage increase for fast food workers in New York.

The country’s most stringent equal pay laws went into effect Jan. 1 in California. These new laws require that men and women holding the same positions be paid equally. Also this year, Oregon becomes just the fourth state in the country to require paid sick leave for employees. The new statewide law requires employers with at least 10 workers to provide up to five paid sick days a year.
 

3) Worker classification: New guidelines from the Department of Labor expand the definition of what an employee is in order to ensure employers aren’t designating some of their workers as independent contractors to save overtime and benefit costs.

Based on these new guidelines, employers should examine their third-party relationships and monitor state and federal agency developments to assist in the efforts to appropriately classify workers.
 

4) Privacy: Many states have either recently enacted or are considering a wide array of stricter privacy and security laws. These include new minimum levels of encryption and security controls, and stricter notification processes and remediation steps when data breaches do occur.

With this in mind, businesses should be prepared to increase the data-security measures they have in place.
 

5) W-2 filings: While, previously, employers had until the end of February or March to file their W-2 forms with the state, those dates are being moved up.

In order to close the gap between when employees receive their W-2 forms and when employers need to have those documents filed, 11 states, along with Washington, D.C., and Puerto Rico, now require employers to file both annual reconciliations and W-2 forms by Jan. 31 each year.
 

6) Retirement plans: By this summer, the Department of Labor is expected to release new regulations that may affect the availability of retirement plan advisors and may result in more scrutiny of a business’ selection and ongoing monitoring of its retirement service providers.

In addition, states may start to mandate that employers not providing 401(k) or similar retirement plans have their employees participate in a state-sponsored plan.
 

7) Credit card fraud: In October, new credit card security measures went into place that increase the standards for cards equipped with computer chips and the technology needed to authenticate chip-card transactions.

With this change, liability for credit and debit card fraud shifts from issuing banks to merchants who have not yet installed new EMV terminals and processes. The businesses should work with their credit card processors in 2016 to ensure compliance with the rules, so that they aren’t held liable for any fraud.
 

8) Online sales tax: Recent changes in the congressional leadership could increase the chances of legislation being passed that would allow states to collect sales tax from online businesses, regardless of where the businesses have a physical presence.

Currently, states are limited by federal mandate to collect tax only on online purchases in which the seller has sufficient physical presence in the state.
 

9) Workers’ compensation: 2016 could see some states weakening requirements related to the insurance costs and processes of workers’ compensation. Facing this possibility, some in Congress have said the federal government may need to step in to maintain worker protections and increase oversight.

How Alternative Lending Has Helped The US Economy And How It Works

How Alternative Lending Has Helped The US Economy And How It Works

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According to the Small Business Administration, more than half of Americans own or work for a small business. In fact, small businesses create about two out of every three new jobs in the United States each year, making them an integral part of our economy.

Despite this importance, many small businesses continue to have a hard time securing the funding they need to grow and thrive – at least through traditional banking. If you’re a small business owner, you may have already learned this the hard way.

Why is it so hard for a small business to get a traditional loan? Let’s take the example of a small retail boutique owner who needs a loan but has little to offer in assets to secure it. Say this owner goes to her local bank and applies for a $20,000 loan. The odds are she won’t get a loan approval, but will instead walk away with a credit card application. This is because from a bank’s perspective, that’s about all they can do. Loans of this size simply are not profitable. The cost and considerable manpower required to process them don’t really move the needle for the bank.

In contrast, more agile online lenders such as Premier Business Lending leverage technology to cost-efficiently process hundreds of applications a month. This makes it entirely feasible for us to work with small business owners whose loan needs aren’t as large. In fact, we strive to deliver the best alternative to traditional bank loans by making our terms fair and our application process as easy, fast, and straightforward as possible.

The American economy relies upon small businesses for stability and growth. However, to grow, expand and ultimately succeed, small businesses require consistent and reliable access to capital. According to the U.S. Small Business Administration’s Office of Advocacy, young firms rely heavily on external debt, receiving about three-quarters of their funds from banks via loans, credit cards and lines of credit.

Data provided by the Office of Advocacy reveals that in 2013, over 5.4 million loans were approved for small businesses. Borrowing amounted to about $1 trillion — including $585 billion in outstanding business loans and $422 billion in credit from finance companies, with the rest from a mix of sources. The increased demand for quick and easy access to working capital has sparked fierce competition among lenders to provide alternative lending options that meet the needs of small businesses; however, the type of financing they require will vary depending on the industry and stage of the business.

Here are four principal reasons that small businesses need to borrow money and some alternative lending options available for each:
 

1. Starting a Business

The average cost to start a business can range anywhere from a few thousand dollars to over $30,000, depending on the nature of your business. It is often difficult to get approved for a loan because most lenders want to see a track record of success and profit.

If you’re starting a business and need start-up capital, first figure out how much you need. Then, look into raising the necessary funds. If securing a bank loan isn’t possible, consider reaching out to your immediate network of family and friends to raise the initial seed money or seek crowd funding agencies.
 

2. Expansion

Once you have your business off the ground and have established a track record of success, it may still be difficult to obtain a small business loan to finance business-growth operations. Premier Business Lending offers a credible alternative for businesses to get a quick loan.

In order to qualify, you must have at least $100,000 in revenue at the end of your first year in business, and a credit score of at least 500.
 

3. Purchasing Inventory

Product or retail-oriented businesses often require financing to purchase additional inventory, keep their shelves stocked and maintain profitability and reputation. Due to seasonal shifts in the number of sales and cash flow, businesses may experience a greater demand for a product at certain times of the year. An inventory loan can help bridge that gap.
 

4. Strengthening the Firm

Revenue-based financing is a great alternative for businesses that are growing and/or have a fluctuating cash flow that requires a more consistent stream of funds to keep the business running strong. There really isn’t a “one size fits all” lending solution for every business.

Chris Wilcox, Managing Partner with Premier Business Lending says “You’re going to want to choose alternative lenders that are focused on improving the experience, when applying for capital. If you’re an early-stage business or a start-up, focus on microlenders that have online loan applications. If you’re a later-stage business, focus on nonbank Alternative lenders that have online loan applications, or community banks/credit unions that have online loan applications.”
 

A multitude of options are available for small businesses to obtain the capital they need to start up, sustain operations, expand and ultimately succeed. Having a solid understanding of the options available and how they meet your business needs is key to determining the lending option that is not only best for your small business, but will offer a quick turnaround and quality user experience.

What is Alternative Lending?

What is Alternative Lending?

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Many of our clients first come to us with little or no knowledge of the alternative lending industry. Most simply have a need for additional capital and have been turned down by traditional “big bank” lenders and are unaware of the many alternative lending options available on the market today.

In fact, big bank lenders approved a record-low 14.8% of small business loan requests in October, 2012. As more business owners and start-up companies become frustrated with traditional lenders and come to Premier Business Lending for answers, we thought now would be a great time to answer a few questions about the steadily growing alternative lending industry.
 

What Exactly Is Alternative Lending?

Alternative lending is a broad term used to describe the wide range of loan options available to consumers and business owners outside of a traditional bank loan. These alternative options are most commonly used when an individual or business owner cannot obtain a traditional bank loan for any number of reasons.

Alternative lenders specialize in utilizing overlooked sources of collateral such as real estate or even outstanding invoices to secure the loan. They are typically more flexible than banks when it comes to repayment schedules and loan approval and often provide cash much faster than their traditional banking counterparts.

The alternative lending industry is well established and generally staffed by well respected members of the financial services community.
 

But Aren’t Alternative Loans Too Expensive?

While alternative loans may sometimes have higher interest rates than traditional bank loans, they fill the gap for small businesses everywhere, providing much needed funding for cash-strapped businesses that have been unable to obtain a loan or line of credit from traditional banks.

This gives business owners the opportunity to invest back into the business, manage cash flow and continue to operate for years to come. Any reputable alternative lender will speak with you at length about the best loan program for your business.
 

What Types of Alternative Loans Are Available?

There are many different types of alternative loans and several methods for collection as well. Premier Business Lending commonly handles hybrid business lines of credit and asset-based lending for our clients, both of which are good sources of fast, liquid capital for business owners.

Other types of alternative loans include medical practice loans which are designed to help grow medical practices, export loans for export businesses, and equity investment loans in which the lender purchases equity in the borrower’s business.

Why the Age of Your Business Matters to Lenders

Why Business Age Matters to Lenders

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One of the many factors that a lender considers when evaluating the credit worthiness of a business is their track record. This means the longer the business age, the longer the track record. This can present a huge disadvantage for newer businesses and recent start-ups.

In fact, according to the SBA, as a potential loan applicant, an owner of a new business needs to show evidence that there is a track record of profitability and success in a similar business endeavor.

The business age impacts the business credit profile which a lender uses to make decisions about your business. In other words, the more years of credit history that demonstrate your business can properly use and repay its business loan obligations, the better.
 

“Thin” Credit Profiles

If you’ve ever been told that your business credit profile is too “thin,” this simply means there’s not enough credit history to accurately evaluate your business. A potential lender tries to predict what your business will do in the future based upon what it has done in the past.

Consequently, if your business has a lengthy track record of borrowing, making regular payments, and repaying debt in a timely manner, your business may be a better risk than a company with a very short history and business age.

This means that if you’ve only been in business for a year or two, you’ll need to take some time to build a strong credit profile. The downside is that there are no real shortcuts to building your profile. Although there are no quick fixes, there are steps you can take.
 

5 Tips for Building a Solid Credit Profile

Here are some things you can do now to build a profile despite a shorter business age when looking for a small business loan:

  1. Realize it does take time: Be prepared to invest some time. The good news is that 12 to 24 months of effort and positive activity will be make a significance improvement in your credit profile.
  2. >Know your credit profile: Your business profile is made up of your credit history and details about your business. It includes information such as your time in business, your industry, and other similar information. It is critically important to be sure your information is accurate.
  3. Stay current with all your bills: The best way to build a strong profile is to pay all your business bills on time. Having a lengthy business age doesn’t matter if you make many late payments. Too many late payments will quickly hurt your business credit profile.
  4. Don’t rely on personal credit: When starting a business, many entrepreneurs will use the equity in their home or personal credit cards to finance it. However, this does not build your business credit profile. Having a business credit card or credit from vendors and suppliers is a good way to establish business credit.
  5. Be sure your credit history is being reported: If it’s not, you may be building a good credit relationship with card companies and vendors without building a strong credit profile. No matter your business age, no reporting won’t help you.

Also, check to see where your credit history is being reported. For example, many online lenders report to the bureaus while others like merchant cash advance providers typically do not.
 

Overcoming The Short Business Age Burden

Building a strong business credit profile is one of the most important things you can do to access borrowed capital with a shorter business age. And this can take time.

However, these five tips will help you build a business credit profile that will provide you options when it comes time to apply for a small business loan.

What The Federal Interest Rate Change Means For Small Business

What The Federal Interest Rate Change Means For Small Business

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In addition to the decisions and strategies implemented by a small business, there are also external factors that impact the financial decisions of small business owners. One the more significant factors is the current interest rate and the actions of the U.S. Federal Reserve to determine interest rate change.

The Federal Reserve chose not increase their rate during the Federal Open Market Committee meetings on March 15th and 16th 2016. The Federal Open Market Committee is the Federal Reserve’s policy-making committee. The committee meets again in April and then in June. However, analysts and investors do not expect another interest rate change until June 2016.

The plan, however, was originally for the Committee to raise its benchmark rate about one percentage point, most likely in four quarter-point increments. But federal officials delayed those plans after financial conditions tightened in January because of concerns about the health of the global economy.

The move went over well with investors. When the Fed made its announcement that there would be no interest rate change, the Standard & Poor’s 500-stock index rose sharply and closed up 0.56 percent for the day. After a rough start to the year, the major stock gauges had almost recovered their losses.
 

The Federal Reserve and Small Business

The Federal Reserve, or the “Fed” as it’s commonly called, impacts how much currency is in circulation, any interest rate change for institutions lending money, and is responsible for controlling the country’s monetary policy.

One of the main ways the Fed maintain its monetary policy is their benchmark short-term interest rate. This rate ultimately impacts everything from the price of groceries cost to the ability for businesses to hire new employees. Any increase or decrease in this rate inevitably spurs a subsequent interest rate change across the board.

Why is this?

Because high interest rates means it costs businesses more to borrow capital, while low interest rates make it cost less. At the height of the Great Recession, the Fed lowered its interest rate to near zero for the first time in U.S. history.

The Federal Open Market Committee did this in response to the fact that credit had dried up, and they hoped to spur bank lending to stimulate the economy. It took a long time for some semblance of economic recovery to come about and, during this time, interest rates have stayed at 0.0-0.25 percent.

The Fed kept its own interest rates at this level from December 2008 until December 2015 when it made an interest rate change from 0.0-0.25 percent up to 0.25-0.5 percent. During this seven-year period of near-zero rates, a large number of small businesses opened and closed their doors, while many entrepreneurs launched new enterprises and the economy slowly improved.
 

How Does This Benefit Small Businesses?

As previously noted, when an interest rate change results in an increase in rates, capital becomes more expensive, which means those owners looking for a small business loan may end up paying more in the long run.

However, many alternative lenders such as online lenders are not bound by this rate the same way traditional banks are. This can provide many more options for small business owners looking to access capital.

According to some analysts the decision not to hike rates could bring additional economic woes. However, despite some uncertainty in certain sectors regarding the central bank’s decisions, the bottom line is that small businesses can benefit from pursuing a working capital loan if necessary.

What Are No Collateral Business Loans?

What Are No Collateral Business Loans?

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When you want to grow your business, obtaining a small business loan is a common approach for making it happen. However, there are a variety of loan types that can be considered, including “no collateral business loans.”

No collateral business loans can be defined as loans that utilize a borrower’s promise to pay as security, versus a physical or tangible instrument of value. In a collateralized loan, like a car loan, failure to pay means that a lender can repossess the item used as collateral. With no collateral business loans, however, no physical item is placed as security for the new loan.

As many small business owners have discovered the hard way, in order to get, sometimes you have to give. This is especially true when it comes to obtaining loans. Oftentimes lenders will require owners to pledge collateral against a loan. Lenders use secured loans as a way to cover their bases in case the borrower defaults.

This way, even if a business owner is unable to pay back their loan, the lender has some recourse in the form of selling whatever asset has been pledged to cover the costs. However, this isn’t always a viable option for business owners, which is why unsecured, or no collateral, business loans may be the ideal alternative.
 

The Versatility of No Collateral Business Loans

The benefits of both collateralized and no collateral business loans are distinct. Loans involving the use of collateral will typically have lower interest rates and longer terms, which can provide a low payment. No collateral loans are usually of a shorter term and have a higher interest rate. This can drive up the overall cost of the loan because of significantly higher risk business loan to the lender.

No collateral business loans, however, are versatile loan offerings that can be used for practically any purpose. An example is using a no collateral loan to pay outstanding business taxes. By taking out a small, no collateral business loan, taxes can be paid and any collection efforts stopped.

No collateral business loans are also great for small business owners looking for direct capital to expand or improve their businesses. This is because there is no chance that they will lose their personal assets in a worst case scenario.
 

The Downsides of Unsecured Business Loans

There are a few issues associated with unsecured loans that can make them less than ideal for many small business owners.

No collateral business loans are difficult to get from traditional banks. For one thing, loans with no collateral requirement are inherently higher risk for banks, which means there are exacting standards for applicants and they will often disqualify business owners due to “high risk loan” business models, bad credit, and other issues.

Additionally, unsecured funding will have higher interest than other programs and rigid payback structures that can put excessive strain on business cash flow.

Business owners may find that because of the difficulties getting approved for no collateral business loans, they may not even be eligible for the funding they require. Even if they are approved, they may be lumped into a generalized program that is not accommodating to the needs of their unique business.

Alternatives for Business owners

Premier Business Lending understands today’s small business owner and their financial needs. Our goal is to help navigate your business through today’s financial marketplace while providing long term financial solutions and support for the small business.

Everyday small business owners deal with the daily stresses of running their businesses. And because of unexpected economic challenges, or business opportunities, there are many times in which additional capital is a real need. We provide quick online lending along with loan terms as short as three months and as long as five years. Premier Business Lending has become a significant resource for today’s medium to small business owner.

How To Calculate Business Loan Fees

How To Calculate Business Loan Fees

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If you’re starting a business or looking to grow your existing business, a small business loan may be a viable financial strategy. Keep in mind that when you repay a small business loan, however, you’ll end up paying more than the amount borrowed because of interest, amortization, and business loan fees.

All small business loans come with interest that the borrower pays to the lender and loan rates can be varied or fixed.

Variable rates change over time as market interest rates shift. If market rates are high, a variable rate can be a good idea since the loan rate will decrease if market interest rates drop.

Fixed rates lock in the market interest rate at the time a borrower takes out the loan. If market rates are low, it’s wise to get a fixed rate and maintain that low interest rate throughout the duration of the payment schedule.
 

Understanding Amortization

The loan’s term, or how long it takes to pay off, affects the overall cost of the loan because it determines how long interest is paid. This is known as amortization which can be defined as the gradual repayment of a loan in equal (or nearly equal) installments which include portions of interest and principal amounts.

Although interest is not typically considered in the same category as business loan fees, it is still part of your cost for borrowing a sum of money. Calculating your amortized interest payments is done with a payment, or amortization schedule. This is a plan for paying back a loan in regular monthly increments.

Each payment consists of principal and interest. For example, assume you have taken out a $100,000 loan for five years with a 5% interest rate. Each month, you’ll repay $1,887.12 in principal and interest.

At the beginning of the term, the larger portion of your payment is interest. Consequently, $416.67 of your first payment is interest and $1,470.46 goes towards the principal.

With each payment, the interest portion decreases and the principal payment increases. In our example the interest amount has decreased by $6.13 on the second payment and the principal portion increased accordingly:

Business Loan Fees Calculation

In the final month, you would only pay $7.83 in interest and $1,879.29 in principal to pay off the loan.
 

Looking at Other Typical Business Loan Fees

As a borrower you will also have to pay business loan fees. Most common are origination and guarantee fees, but some lenders will have additional costs. Often you will have to pay interest on any fees that are added to the loan rate. This increases not only the amount loaned, but the total interest charged as well.

Origination fee – An upfront fee that is charged for processing a new loan. Lenders charge borrowers this fee for processing a loan application and other administrative work involved. It’s taken as a percentage of the total loan, for example, 1% of a $100,000 loan.

Guarantee fee – For SBA-guaranteed loans, lenders pay the government a portion of the amount guaranteed. Many lenders pass on part of this cost to the borrower.

Underwriting fees – These are business loan fees collected by underwriters who verify and review all of the information you’ve provided.

Closing costs – These business loan fees can include other costs associated with servicing the loan such as a loan-packaging fee, a commercial real estate appraisal or a business valuation.

Unfortunately, business loan fees are unavoidable and can add a significant amount of money to your loan. Each lender should give you a list of what each fee includes and should explain any fees that you don’t understand.

Business Loan Principal vs Interest: What's The Difference?

Business Loan Principal vs Interest: What’s The Difference?

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Most small businesses are unable to make major purchases without taking out business loans. Understanding how the loan process works is important for business owners and others looking to take on a loan. This includes having a clear understanding of principal vs interest.

Businesses must pay interest, which is simply a percentage of the amount loaned, to the institution that loans them the money. These loans could be for vehicles, buildings, or other business needs. The amount loaned is what is called principal, or the actual loan amount.
 

How Interest Is Calculated for a Business Loan

Banks actually use two types of interest calculations:

Simple interest, which is calculated only on the loan principal vs interest accrued on amount of the loan, which is how compound interest is calculated. In other words, on both the principal and on interest earned.

Simple interest is the simplest formula to calculate. Here’s an example of simple interest where “n” represents the life of the loan:

Principal × interest rate × n = interest
To show you how simple interest is calculated, assume that you borrowed $10,000 from the bank for a building loan at five percent (0.05) interest for four years. When the loan principle is repaid after four years, the interest accrued is two thousand dollars, or $10,000 × .05 × 4 = $2,000.

Notice that the total interest rate on the balance vs interest paid is determined by the life of the loan. In theory, if the loan were repaid in full in only two years the total interest accrued would only be $1,000.

Compound interest, on the other hand, is not computed on just the principal vs interest accrued like the previous example. The interest per period (monthly or annually) is based on the remaining principal balance plus any outstanding interest already accrued. The total loan interest compounds over time.
 

Types of Business Loan Repayment Plans

You and your lender can potentially arrange for a number of repayment plan options. Let’s say you borrow $10,000 with interest at the rate of 10% a year. Here are some of the more common business loan repayment possibilities:

Lump sum repayment: You might agree to pay principal and interest in one lump sum at the end of, say, one year. Under this plan, after 12 months you’d pay the lender $10,000 in “principal”, or the borrowed amount, plus $1,000 in interest.

Periodic payments of principal and interest: You would repay $2,500 of the principal vs interest amounts that decrease at the end of each year. Under this plan, your payments would look like this:

Year one you pay $2,500 of the principal plus $1,000 interest.
Year two you pay $2,500 of the principal plus $750 interest.
Year three you pay $2,500 of the principal plus $500 interest.
Year four you pay $2,500 of the principal plus $250 interest.

Amortized payments: This type of arrangement requires you to make equal monthly payments so that principal and interest are fully paid in a certain time period. Under this plan, you’d have an amortization table to figure out how much must be paid each month to fully pay off a $10,000 loan principal vs interest of 10%.

Each of your payments would consist of both principal and interest. At the beginning of the repayment period, the interest portion of each payment would be larger and decreasing towards the end.
 

Know What You Owe

To sum up, a business loan is a simple matter of paying the full amount of the principal vs interest amounts, which can vary not only in the percentage applied, but in the manner it’s calculated. Once you are ready to move forward with the loan process, be sure you know how much the interest is going to add up to in an actual dollar amount over the life of the loan.