In this era of quick and short financing, it is understandable that small business owners overlook installment loans. After all, they require more documentation than some of the other types of credit products on the market.
But this type of loan – where you get a lump sum that you pay back over a set period of time – gives you predictability and a fixed interest rate that could prove beneficial as your business grows.
“I like installment loans because the payment can vary on other loan products and it’s unclear what the APR is,” Joseph Meuse, founder and president of Business GPS, told business.com. “Many business owners know how to deliver a product or service, but they are not a CFO. The credit product is easy for them to understand and budget for.”
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How do installment loans work for businesses?
Corporate installment loans work like a mortgage or car loan: You borrow a lump sum and have to pay it off over 12, 24, 36, 48 or 60 months, sometimes longer. The interest rate you pay on the loan is fixed and depends on your creditworthiness. The cost of financing is much lower for high credit borrowers than it is for bad credit borrowers. Installment loans can be used, among other things, to purchase working capital or real estate, to provide working capital, or to consolidate debt.
Whether an installment loan is the best financing product for your company depends on why you need the money.
“You don’t want to go into debt for too long to find a solution to a cash crunch you may have,” said Josh Jones, chief revenue officer for Kapitus. “Knowing your needs is super important.”
What types of installment loans for businesses are there?
Small business installment loans can be used to buy a vehicle or office equipment, purchase property, or pay off expensive debts. They come in different terms depending on your business needs.
- Long term loan: These loans have terms of six years or more. They are typically used for large purchases such as a company vehicle or property.
- Medium term loan: These loans have terms of two to five years and are commonly used to purchase office equipment or to finance expansion.
- Short-term loan: These loans have terms of less than two years. They are typically used to buy inventory, fill liquidity gaps, for working capital, or for other short-term cash requirements.
The longer the term of the installment loan, the more interest you pay and the more difficult it is to get approval. Lenders take a greater risk if they commit to you for six years instead of 18 months, and therefore charge more.
“Whether you’re using it on a vehicle, equipment, or a mortgage, make sure you use the money on something you bought over the repayment period,” Jones said. “If you don’t use the money beyond the repayment terms, an installment loan may not make sense.”
What do you need to apply for a corporate installment loan?
A small business installment loan is not as easy to come by as other financing options. Banks, credit unions, and alternative lenders all offer installment loans, but expect higher credit ratings and greater business strength than other types of financing. This is especially true during the COVID-19 pandemic, as lenders are still more risk averse. That means you need good credit, solid business, and a willingness to offer collateral.
“If you have assets, equipment, real estate, or accounts receivable that you can use as collateral, an installment loan is for you,” said Meuse. “More documentation is required these days, sometimes a slightly higher credit rating and sometimes a loan [ratios] less, but the lenders have a good appetite. “
From your creditworthiness to business account statements: Here’s what it takes to apply for an installment loan.
Lenders are risk averse, so your chances of getting a low interest installment loan largely depend on your proven ability to repay. This is where your business and personal creditworthiness comes in. Unless your company has been in business for years and has solid sales growth, lenders will do your personal credit checks to assess your creditworthiness. If your credit score is low, your loan application will either be rejected or you will be charged a higher interest rate. Banks and credit unions typically have higher creditworthiness requirements than alternative lenders. Some lenders offer to business owners with poor credit ratings.
Business installment loans are usually collateralized, which means that you have to provide collateral. Collateral can be assets such as equipment, accounts receivable, or real estate that the lender receives if you default on the loan.
Unless you’re an established business with years of revenue growth, lenders need more than just collateral; They will ask for a personal guarantee from you. This is a legally binding statement that if your company cannot, you will personally repay the loan.
In order to approve you for a loan, lenders want to know a little about your business. This is where the business plan comes into play. You want to have a compelling story, presented in a presentation or on paper, that shows your plans and your growth paths. It should be clear, concise, and detailed, and show lenders a solid business idea. The plan should include how much money you will need and why, how you will pay back the loan, and what assets you want to provide as collateral.
Business and personal documentation
Lenders need a lot of business and personal financial records in order to approve your loan application. Banks and credit unions require more paperwork than alternative lenders, but in either case, it is important that you have everything ready before you apply. Each lender has their own documentation, but these are the most common requirements:
- Bank statements
- tax returns
- Business plan
- Proof of company ownership
- Personal information
Installment loans are a viable option for small business owners if they shop smart and select the best lender for them. You don’t want to get stuck with a high interest loan and loads of hidden fees. Because of this, Libby Morris, vice president of operations at Funding Circle US, said it was important to be aware of all the costs associated with an installment loan.
“One of the things we look for in our responsible lending business is whether they disclose all of their fees?” said Morris. “Small business loans are not as regulated as consumer loans. You can see a good interest rate and all these hidden fees.” Morris said you should avoid lenders charging early repayment penalties on your loan.
When applying for an installment loan, be prepared for a counter offer from your lender, especially in the current environment. With the coronavirus still out of control, lenders are cautious about taking excessive risks. You have an appetite for credit but you may not want to be as generous as you hope you will be. Morris said it was unsurprising to see a business owner apply for $ 500,000 and get approved for $ 300,000.
“You have to be flexible about how much you really need,” she said.