28/02/2024

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9 Types of Business Loans Explained

9 Types of Business Loans Explained

There are many types of business loans that you can use to access capital quickly — whether it’s for operating expenses or financing a high-value transaction. The best funding option depends on your business needs, monthly revenue and how quickly you can repay the balance.

Here’s a look at the different types of business loans to help you determine the best option for your company, whether you need to borrow a small amount or make a major purchase.

1. Term loan  

Best for: Fast funding

Small business term loans let you borrow as little as $5,000, while well-qualified companies are eligible for up to $500,000 in funding. Repayment terms range from just three months to as long as five years with fixed daily or weekly payments. Long-term loans can have higher borrowing limits and more competitive interest rates.

You may also consider this loan option when fast funding is vital to your operations. For example, if you need money soon to make payroll or afford a major purchase. Online lenders typically fund approved applications within one to three business days and also have more lenient annual revenue and business history requirements. 

Still, it’s common for lenders to request collateral or a personal guarantee to qualify. The personal credit score requirements vary but can be as low as 500.

The interest rates and origination fees for term loans can be higher in exchange for the ease of access. 

2. Business line of credit

Best for: Multiple withdrawals

A business line of credit lets you borrow money when you need it as expenses arise. This loan provides more flexibility and can minimize your interest expenses when a lump-sum term loan isn’t the best fit for your funding needs.

Most lenders offer credit lines from $2,000 to $250,000, which is sufficient for most startups and small businesses. Consider this option as an alternative to term loans when you can successfully manage repaying multiple draws. 

This revolving account has a draw period during which you can withdraw from your available line of credit repeatedly, as necessary. As you borrow money interest begins to accumulate. You must begin paying down your outstanding balance in order to replenish the amount of money available to be borrowed. Once the draw period closes, you must make both principal and interest payments. 

Loan amounts, rates and fees can vary for this loan type. A secured line of credit can offer lower rates but requires collateral-backed assets and a personal guarantee. As a result, be sure to compare your repayment options and fee schedule from several lenders.

3. Equipment financing

Best for: Buying or leasing business equipment

Equipment financing loans can provide more favorable rates than a term loan for pricey business equipment purchases. Your equipment secures the loan making it possible to qualify for a higher loan limit and a longer repayment term.

Because the loan is secured by the equipment you’re purchasing, you may be able to get lower rates than with a small business term loan or line of credit. Depending on your loan amount, you may not need to make a down payment. However, your equipment can be repossessed if you default. 

While you can borrow large amounts of money for many years, you will want to evaluate your equipment’s potential lifespan to avoid a repayment schedule that extends after the piece’s replacement date.

4. Invoice factoring

Best for: Unpaid invoices

Invoice factoring provides a cash advance on pending invoices so you can maintain consistent business revenue. This type of business loan requires selling pending invoices to a lender and you receive a cash advance minus a factor fee.

The lender then collects payment from the client. Your factor rates will be lower when the client has good business credit and when you do too.

When using invoice factoring to access cash, it’s possible that you may be on the hook for paying off a delinquent invoice yourself — as there are two different invoice factoring structures available to borrowers:

  • Recourse factoring: You are responsible for repaying the lender if one of your clients doesn’t repay the invoice. This loan agreement is more common. 
  • Non-recourse factoring: You are not responsible for repayment if a client fails to repay their invoice. The lender assumes all risks.  

5. Merchant cash advance

Best for: Cash advances

A merchant cash advance is a compelling lending option when you process credit and debit card purchases frequently. This funding option lets you use future cash flow to receive a cash advance. Your repayment schedule is based on the percentage of your daily sales.

As this is a short-term borrowing solution, you pay a factor rate instead of interest which is more expensive than a term loan. Additionally, most lenders require daily payments that may be challenging to afford on days with minimal revenue.

You may appreciate this option if you have bad credit as lenders place more emphasis on your business revenue than your credit. However, business owners with a low personal credit score or who operate in a high-risk industry are likely to pay a higher factor rate.

Additionally, you may not need collateral but the lender may require direct access to your merchant account or payment hardware. 

6. SBA loans

Best for: Long repayment terms

SBA loans are issued by participating lenders and are partially insured by the U.S Small Business Administration. There are several loan options, which provide higher loan amounts along with more competitive rates and terms than a business term loan. In addition, these loans can be used for a variety of purposes.

“For example, SBA 7(a) loans can be used for acquiring a business, improving real estate and for other short-term and long-term capital needs,” says Eric Nelson, president and financial advisor at Independence Wealth. “However, a SBA 7(a) loan would likely not be ideal for acquiring real estate due to the shorter amortization schedule. For business real estate, a SBA 504 loan would likely be more appropriate,” Nelson suggests.

SBA loan types include: 

  • SBA 7(a) business loan: Loan amounts up to $5 million and a maximum 10-year repayment term. Funding can be used for working capital, inventory, business expansion and equipment acquisition.
  • SBA 7(a) real estate loan: Can borrow up to $5 million for up to 25 years towards real estate-related purchases and expansions.
  • SBA 504 real estate loan: Loan amounts of up to $12.375 million for the purchase, refinance or construction of commercial real estate. Repayment terms are as long as 25 years. 
  • SBA Express loan program: Funding amounts from $25,000 to $500,000 with a fixed interest rate for up to 25 years. 

Unfortunately, it can take from 30 to 90 days to receive funding and the lender-specific borrower requirements are relatively strict. A general rule of thumb is to have a minimum 620 credit score and at least two years of business history. You will need to contact an SBA lender directly to review your loan eligibility.  

7. Commercial real estate loan

Best for: Real estate acquisitions

A commercial real estate loan can provide higher loan amounts with a lengthy repayment period of up to 25 years. You can use the funds to buy, renovate or refinance owner-occupied properties.

Many lenders offer fixed interest rates and an amortization schedule with the same monthly payment for the life of the loan. However, some lenders may require a balloon payment for shorter repayment periods.

This loan can be a good alternative to SBA real estate loans, depending on your business history and funding needs. 

8. Unsecured personal loans

Best for: New businesses

A competitive personal loan can be an excellent option when you are starting a business or don’t satisfy the annual revenue and operating history to qualify for other types of business loans. 

Further, many personal loans are unsecured and don’t require collateral. However, you may consider a secured loan to qualify for a better interest rate, higher loan amount or to offset poor credit. 

Instead, you are eligible when you have a qualifying personal credit score and income history. Several lenders consider applications with a credit score of 580 or higher, although having good or excellent credit helps you qualify for lower rates.

Depending on your creditworthiness, you can borrow anywhere from $1,000 to $50,000, depending on the lender. These loan amounts are smaller than a typical business loan. Most loans have a repayment term of three to five years with fixed interest rates and monthly payments.  

You can use funds from an unsecured loan for many purposes, including debt consolidation and business expenses. Some lenders only permit using proceeds for personal expenses so it’s worth double-checking the acceptable loan purposes before applying. 

9. Business credit cards

Best for: Smaller expenses

Business credit cards are useful for small business purchases that are too small for a loan. You may also choose this payment method when you want to avoid applying for new financing when you have limited income.

Strive to pay your account balance in full each month to avoid interest charges. Business credit cards have variable interest rates that can fluctuate at any time and will likely be higher than other borrowing methods. 

In addition, your credit limit can also be lower than term loans or lines of credit and depends on your credit and income history. Most business credit cards require a personal guarantee that can impact your personal finances if your business assets cannot pay off the balance. 

How to determine the right type of business loan for you

There isn’t a single best option. Some initial factors to consider when applying for a business loan are your business history, borrowing needs and if your personal credit is impacted.

Compare lender requirements

Each loan type and lender has differing borrowing requirements. Typically, you need to earn a minimum amount of revenue and operate for several years. 

The best business loan for you depends on several factors, including:

  • Current revenue.
  • Desired loan amount.
  • Funding speed.
  • Length of business history.
  • Loan purpose.
  • Personal credit score.
  • Repayment period.

“When determining the right business loan for your needs, it’s crucial to assess the nature and urgency of your financial requirement,” says Doug Greenberg, founder and president at Pacific Northwest Advisory. “For businesses with consistent cash flow but occasional shortfalls, a line of credit may be apt. For those looking to leverage unpaid invoices, invoice factoring becomes relevant. Always weigh the cost of the loan, terms, flexibility and speed of approval against your business’s specific needs.”

Estimate fees and monthly payment

You should also review the upfront fees and total interest costs, which can vary widely between loan types. Consider using a business loan calculator to estimate your monthly payment and find the most affordable option. 

It’s common for business loan lenders to require a personal guarantee, so you want to be comfortable with the repayment schedule and minimum payment. Otherwise, you are responsible for repaying the remaining balance with your personal assets.

Consider funding speeds

Many loans and credit lines deliver your funds within a few business days after approval. Receiving your funds quickly can help address a near-term cash crunch.

Frequently asked questions (FAQs)

Online loans for startups are usually the easiest lending option to qualify for and offer high loan amounts and flexible repayment terms. Depending on the lender, you may only need as little as $15,000 in monthly revenue and six months of business history. 

Merchant cash advances and invoice factoring can also be easy as well, as they’re based on your business revenue, not its history or credit score.

Unsecured business loans are typically the best option for new businesses and organizations with small yet consistent cash flow. Businesses needing to make multiple draws should consider a business line of credit or a business credit card. Lenders have minimum annual revenue and time in operation requirements, so your personal credit can help you qualify. 

“For businesses with established cash flow, invoice factoring, lines of credit and short-term loans allow flexibility and access to capital while keeping repayment tied to your actual income,” says Jorey Bernstein, CEO of Bernstein Investment Consultants. “Match the loan to your operations, understand all terms and fees and partner with lenders invested in your success.”

Online lenders are more likely to have more flexible borrower requirements than traditional banks and credit unions. You can also find a variety of lending options including term loans, lines of credit and cash advances with different terms and fees.