Whether starting a company, expanding operations, or attempting to weather a recession, a business loan can be a godsend.
But before you sign your name on the dotted line, it’s essential that you understand what you’re committing to. A business loan is a legal and financial obligation that can haunt your company for decades if you choose the wrong type of loan or borrow more than you can repay.
You should look for a business loan provider offering exactly what you need. It’ll be able to advise you on your best options and equip you to make the right choice.
Here are five things you should consider before signing on the dotted line to get a business loan.
1. Know the Total Cost of the Loan
When it comes to shopping around for the right loans, most entrepreneurs focus on the interest rate. It is a good idea to consider the interest rate, but don’t stop there.
You must understand the total cost of a business loan. That means looking at fixed or variable interest rates, late payment fees, origination fees, prepayment fees, and other applicable administration fees.
A loan with a small interest rate but huge upfront charges could turn out to be more costly than a loan with a slightly higher interest rate but fewer hidden fees. Be sure to calculate the annual percentage rate as well to figure out the actual cost of the loan.
2. Know Your Payback Schedule and Terms
Before you borrow, request the payback terms in writing. Any reputable provider of business loans will give you this information without you having to request it. You need this sort of information to determine whether or not a particular business loan is a good fit.
When looking at payment firms, ask the following questions if you’re uncertain:
- What is the payment term?
- How often are payments made?
- Is there a grace period before payments are made?
- What happens if I’m late making a payment?
Understand the repayment plan so that you will not be caught off guard. That means asking questions if you’re unclear about anything.
3. Assess Your Business’s Ability to Repay
It’s easy to let emotions take over when a lender makes a business loan offer, particularly if you’re short on funds and need to address urgent needs or seize opportunities. But you must be honest about whether your business will have the ability to make the loan payments in a timely manner and on a routine basis.
Lenders will be looking at your debt-service coverage ratio or your cash flow versus loan payments. If your debt-service coverage ratio is over one, you have the financial flexibility to service debt. But if it’s below one, you might have too much debt as it is.
4. Know What You’re Putting at Risk
If you get a secured loan, you must offer up some type of equipment, inventory, or even your personal property as collateral. If you don’t make payments, the lender repossesses the asset.
Unsecured loans may still come with a personal guarantee, which means that you’re personally guaranteeing that you’ll pay if the business can’t. This can risk your personal credit, savings, or property.
5. Consider the Loan Purpose and Potential ROI
Lastly, ask yourself: Why do you want a business loan, and will it drive or sustain your company in measurable terms?
It’s a good idea to spend a loan on things like buying equipment to increase productivity, opening a new office, or spending on a high-ROI marketing effort.
Ensure you have a solid business rationale for the loan, with revenue forecasting and repayment planning.
It is a wise business move to take a business loan, as long as you understand the implications and make wise choices. Before signing a loan contract, consider the cost, repayment period, risk, and ROI.
Founder Dinis Guarda
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