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How Do Business Loans Work? Everything You Need to Know

Loan Concept

Here’s a nugget of wisdom that not all business owners know…

Companies with debt are 19% more likely to make it past the third year compared to those without debt. Also, these borrowers made almost 200% more profits than those with no debt within the same time frame!

All these highlight how big a role small business funding has in an SMB’s success.

It’s not only because 29% of failed start-ups reported lack of funds as the cause of their closure. It’s also because having access to funds allow business owners to grow their company.

Exactly how do business loans work though and how can they help organizations? What do they bring to the table that helps improve an organization’s chances of success?

All these questions, we’ve answered in this post, so be sure to keep reading!

What Business Loans Are

Business loans are financial products that give business owners access to funds. Business owners can use this capital to make investments for their firm.

They can use the funds to cover overhead costs or to buy or lease supplies and equipment. They can also use it to ramp up their workforce or to move to a bigger office space.

There are many types of business loans, ranging from SBA loans to installment loans. There are also specialized lending services, such as business lines of credit.

How Do Business Loans Work? A 100-Word Explanation

The most basic structure of business loans looks like this:

The lender loans a certain amount of money to the business borrower, known as the “principal.” In exchange for these funds, lenders will apply interest on top of the principal. The interest is a percentage of the borrowed amount.

You can think of the interest as the “salary” of lenders — it’s how they also make money by providing you service.

A borrower then pays back the principal and interest over an agreed-upon length of time. Known as the loan term, it’s the length of time a borrower has to make a specified number of payments.

Breaking Down Business Loan Structures

To make things clearer, we’ll use the situation below as an example.

The Capital

Let’s say you need to borrow $50,000 to cover overhead expenses and equipment purchases. The lender agrees to lend you that money, so your loan principal is $50,000.

The Loan Interest Rate and Monthly Interest Payments

The loan interest rate is one of the factors that determine how much you have to pay the lender back every month. This rate is often expressed in annual percentage rate (APR). APR already includes all extra costs associated with the loan, except for compounding.

Let’s say the APR is 5%. Multiply this by the principal ($50,000), and the answer — $2,500 — is the total yearly interest payments you need to make. Divide that by 12 (months), and you’ll get $208.34 — that’s how much your monthly interest payments will be.

The Term

The term you choose also influences the amount you have to pay on a regular basis. The longer the term is, the lower the monthly payments you have to make.

However, this isn’t always a guarantee that your total loan costs will be lower. This can also be true for longer-term loans with a lower APR.

Here’s an example of such situations:

Loan Option A: $50,000 at a 6% APR for a 3-year (36 months) term

Over the life of your loan, your total interest payments will be $9,000. Divide the total of $59,000 (principal + interest) by 36 (months), and you’ll pay $1,638.89 every month.

Loan Option B: $50,000 at a 5% APR for a 4-year (48 months) term

Your total interest payments will amount to $10,000, bringing the total loan costs to $60,000. You’ll pay only $1,250 for 48 months, but in the end, you’ll still pay $1,000 more even though it has a lower APR.

Keep in mind that this is only the most basic loan repayment computation. But as you can see, there are many things that can affect your overall loan repayments.

This is one of the reasons you should consider working with a local business bank. They can help you find the best business loan options that don’t come with exorbitant fees.

They will guide you through the entire application of a business loan. They can even develop a specific program tailored to your business’ specific needs.

How Business Loans Can Help Your Company Stay in Business and Grow

From overhead expenses to equipment purchases, business loans can cover these costs. It’s in this way that they can help your business not only survive but also thrive.

Working Capital Loans

One of the best ways to finance businesses, a working capital loan can fund your overhead costs. These are the regular costs of doing businesses, such as rent, mortgage, and insurance. You can also use these loans to buy office supplies or maintain marketing campaigns.

With these loans, you can keep operating even if you face a sudden, huge dip in your finances. This can happen if some of your accounts receivable haven’t pushed through yet. This can also occur if a client you’ve been expecting to receive a down payment from hasn’t paid you yet.

Inventory Financing

Inventory financing is also one of the types of business loans that can help your firm grow. Warehouses, manufacturing facilities, and retailers are the usual applicants for these loans. However, any other type of business that needs to sustain an inventory can benefit from this loan.

Equipment and Vehicle Financing

Did you know that vehicles in the U.S. cost an average of $36,843 in April 2019?

Now, compare that to the average salary of $65,904 that a small business owner in the U.S. makes.

That means that a new car costs almost half of what they make in a year!

For many entrepreneurs though, vehicles and equipment are crucial to their operations. In fact, without these, construction, manufacturing, and food and beverage businesses can’t operate.

The good news is, local banks can help you get the funds you need to make these big-ticket purchases. They offer equipment and vehicle financing at much better rates than alternative lenders.

Boost Your Business’ Success Rate with the Right Business Loans

There you have it, the ultimate guide that answers your question, “How do business loans work?” As you can see, it can be quite complicated, but it can also be easy if you partner up with the best local bank.

Choose the best source of business funding options, and you can worry less about running out of funds. You can then focus on increasing your firm’s productivity and high-quality output.

Ready to explore your business loan options? If so, then we’re very pleased to inform you that you can now apply online for our business loans! Please feel free to get in touch with us too if you need help deciding which financing program is best for your firm.

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