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Understanding Business Loans
Types of Business Loans
- Term Loan: A lump sum repaid over a fixed schedule. Best for specific, one-time needs like equipment or expansion.
- Business Line of Credit: A revolving credit facility — draw what you need, repay, draw again. Best for working capital and cash flow gaps.
- SBA Loan: Government-guaranteed term loan with longer terms and lower down payments. Slower to fund but often the best rates for qualified businesses.
- Equipment Loan: The equipment itself serves as collateral, often enabling lower rates and no separate collateral requirement.
- Invoice Factoring / AR Financing: Sell or borrow against your outstanding invoices. Fast access to cash, but high effective cost.
How Lenders Evaluate Your Business
Banks and commercial lenders use a framework sometimes called the "5 Cs": Character (credit history), Capacity (ability to repay), Capital (your investment), Collateral (assets securing the loan), and Conditions (loan purpose and market).
The most important financial metric is your Debt Service Coverage Ratio (DSCR). Lenders typically require DSCR of 1.25x or higher — meaning your annual net operating income is at least 1.25 times your annual debt payments. A DSCR below 1.0x means you don't generate enough cash to cover the debt, which is a hard decline at most banks.
Documents You'll Typically Need
- ✓ 2 years business tax returns
- ✓ 2 years personal tax returns (owners 20%+)
- ✓ 3–6 months business bank statements
- ✓ Year-to-date Profit & Loss statement
- ✓ Current balance sheet
- ✓ Accounts receivable aging report
- ✓ Business plan (for startups or large loans)
- ✓ Collateral documentation
Fixed vs. Variable Rates
Fixed rates give you predictable payments and protection against rate increases — ideal if you expect rates to rise or you want budget certainty. Most bank term loans and SBA 504 loans are fixed.
Variable rates are tied to a benchmark (Prime rate, SOFR) and can move up or down. SBA 7(a) loans are typically variable at Prime + a spread. Variable can be cheaper in a declining rate environment, but plan for rates to increase.
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