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How do small business loan repayment terms work?

When you take out a loan, the repayment terms describe the amount of time you, as a borrower, have to repay the debt. The loan term will determine how many monthly payments you will make and the amount of those loan payments. Repayment terms vary based on the type of loan, the lender issuing the funds, and the creditworthiness of the borrower. The repayment term, or loan term, greatly impacts the amount of each payment because the term determines how many installments the total loan amount and any financing costs are broken into. 

The term of the loan is not the only factor when considering how much or how long a borrower will have to repay the debt. Other components of a loan agreement that affect a borrower’s repayment schedule include some of the following lending terms.

Servicer

A loan agreement typically refers to the borrower, as the individual that took out the loan, and the servicer, or the financial institution responsible for the financing process. Servicers may be traditional lenders, like banks or credit unions, or they may be alternative lenders or online lenders. The servicer is the institution that issues the initial funds and collects payments throughout the life of the loan.

Annual percentage rate (APR)

Annual percentage rate, called the APR, is the amount paid by the small business owner, or borrower, over the period of one year for the privilege of borrowing the money. The APR gives an annual cost of borrowing the funds and may include broker fees, closing costs, processing fees, underwriting fees, and document fees. The total amount of fees is compiled and expressed as a percentage to give the APR. The APR percentage differs from the interest rate percentage because the APR includes all of those fees, and an interest rate doesn’t.

Interest rates

Almost all types of small business financing options include an interest rate in the repayment terms. The interest rate, like the APR, is expressed as a percentage. The interest is calculated as that percentage of the remaining principal balance of the total loan amount. The interest rate is the primary financing cost with most loans. Interest rates may be fixed, where they remain the same throughout the entire loan term, or they may be variable, where they fluctuate based on the market rate. The amount of interest charged by the lender is determined by the credit score of the borrower, the lender’s policies, and the amount of borrowed funds. Small business owners with an excellent credit history are more likely to receive loan offers with lower interest rates than borrowers that have a bad credit score.

Prepayment penalty

Some loan agreements include a prepayment penalty, which is a fee collected by lenders from borrowers that pay off their debt in full before the end of the predetermined repayment term. Some prepayment penalties also apply to unscheduled payments on the principal balance, even if the loan is not being paid off in full. Most prepayment penalties are expressed as a percentage of the loan amount and decrease over the term of the loan. If there is a prepayment penalty on a small business loan, it will be disclosed in the original loan documents. 

Types of business financing options

As stated earlier, one of the factors that contribute to the repayment terms of the loan is the loan program or type of business financing secured. There are many different loan options for small business owners. Choosing the right loan for your business needs depends on the purpose of the funds, the amount of money needed, and the lender chosen. Many small business owners choose to work with alternative lenders, like Biz2Credit, over traditional lenders because they offer more loan programs and can typically offer more favorable repayment terms than traditional banks.

Term loans

A business term loan is a type of financing where the borrower receives a lump sum of cash upfront and pays the loan back with monthly payments of principal and interest. The repayment terms are agreed on before the funds are released and are determined by the lender based on the amount of the loan and the creditworthiness of the borrower. Term loans can be used for large purchases like buildings, equipment, and vehicles. They are also used for business owners in need of working capital, inventory, payroll funding, or everyday operating expenses. Advantages of a term loan include a predictable repayment schedule and lower interest rates than other financing options.

Typical repayment terms for small business term loans:

  • Repayment term – 3-36 months for short-term and medium-term loans; up to 10 years for long-term loans
  • Loan amount – Up to $500,000
  • Interest rate – Start at 7.99%, depending on creditworthiness
  • Funding time – as little as 72 hours

Working Capital Loans

Working capital loans are small business financing options that can provide capital to entrepreneurs looking to supplement cash flow, implement growth strategies, make necessary repairs or replacements, or cover monthly operating expenses. There are different types of working capital loans, so choosing the best one depends on the type of business using the funds.

MCA

A merchant cash advance (MCA) is not a loan, but a financing option for small business owners where they receive a cash advance in exchange for future credit card or debit card sales. The repayment terms for a merchant cash advance are shorter than some other business loan programs and usually require payments more frequently than monthly, like daily, weekly, or bi-monthly. MCAs can be a great financing tool for any small business that does substantial credit card sales or debit card business, like retail stores and restaurants. The financing costs of a merchant cash advance are typically higher than other loan programs, although they are calculated using a factor rate, not an interest rate. Cash advances offer more flexible eligibility requirements so they are a good fit for entrepreneurs with a poor credit history or no collateral.

Typical repayment terms for merchant cash advances:

  • Repayment term – 3-24 months
  • Loan amount – Up to $500,000
  • Factor rate – Start at 1.1
  • Funding time – as little as one business day

Invoice Factoring and Invoice Financing

Invoice financing and invoice factoring are types of business lending that use the business’s accounts receivables as collateral for a cash advance. Even though the terms are used interchangeably, invoice factoring and invoice financing are different funding programs. Invoice factoring works when a business sells its unpaid invoices to a factoring company, which then collects on the invoice. With invoice financing, the unpaid invoices still act as collateral, but the burden of collection falls on the business. Similar to a merchant cash advance, invoice factoring and financing are expensive means of securing capital, so they are best for borrowers that have exhausted other cost-effective options.

Typical repayment terms for invoice financing and invoice factoring:

  • Repayment term – not predetermined, usually 30 to 90 days
  • Loan amount – Up to 100% of the unpaid invoice balances
  • Financing fees – Processing fee of 3-5%, plus a factoring fee of 1 – 2%
  • Funding time – 24 – 72 hours

Government-backed financing

Some loan programs offer a guarantee from the government, which reduces the risk for the lender and improves a borrower’s odds of getting approved and having a lower interest rate and down payment.

SBA loans

SBA loans are a type of business financing where the loan amount is partially backed by the U.S. Small Business Administration. SBA loan funds can be used for startups, operating expenses, franchise financing, large purchases, expansion, and debt refinancing. An advantage of SBA loans, for borrowers that can meet the approval requirements, are lower interest rates, lower down payments, and longer repayment terms. There are several SBA loan programs, but some of the most common are listed below.

  • SBA 7(a) Loan – SBA 7(a) loans are the most common SBA loan program for small business owners and approve borrowers for loans up to $5 million. The eligibility requirements include three years of business income tax returns, a real estate schedule, and two years of personal tax returns for business owners.
  • SBA 504 loan504 loans are good for entrepreneurs looking for long-term, fixed-rate financing to purchase or maintain major fixed assets. The SBA works with Certified Development Companies (CDCs) to approve these loans for for-profit U.S. companies with an average net income of less than $5 million. 504 loan funds can be approved for up to $5 million for a single project or up to $16.5 million for certain energy projects.
  • SBA Microloans – Microloans provide certain small business owners and nonprofit childcare businesses with loans up to $50,000 to cover startup costs or expansion costs. The Microloans are issued through pre-approved lenders that ultimately determine the interest rates and repayment terms. The maximum term for an SBA Microloan is six years.

Typical repayment terms for SBA loans:

  • Repayment term – 3 – 25 years, depending on the program
  • Loan amount – Up to $5 million, depending on the program
  • Interest rates – Base rate (usually Prime rate), plus 2.25% to 4.75% for 7(a) loans
  • Funding time – 30 – 90 days

Revolving credit options

Revolving credit is a type of financing where the borrower is approved for a maximum credit line and then can withdraw funds and make payments repeatedly within the credit limit and repayment terms.

Business credit card

Business credit cards can be a great financing tool for small business owners. They work like personal credit cards but using business credit cards will not affect an individual’s personal credit report. Advantages of a business credit card include the opportunity to build better credit history and keep business expenses separate from personal finances.

Typical repayment terms for business credit cards:

  • Repayment term – Open-ended, and reviewed annually
  • Loan amount – Maximum credit line
  • Interest rates – Varies depending on credit score, typically starting at 15%
  • Funding time – Upon approval

Business lines of credit

A business line of credit is a type of revolving credit where the borrower applies for and is approved for a maximum line of credit and can then draw on that credit line anytime they need fast funding. The repayment schedules for lines of credit include monthly payments of interest and principal. Business lines of credit are a great financing tool for entrepreneurs that are interested in growing an established business credit score because eligibility requirements are less strict than traditional bank loans.

Typical repayment terms for business lines of credit:

  • Repayment term – up to five years
  • Loan amount – up to $250,000
  • Interest rates – 10 – 99%, depending on creditworthiness
  • Funding time – 1 – 3 business days

What are good repayment terms?

It’s impossible to classify repayment terms as either good or bad because their value depends on the business’s unique circumstances. Repayment periods are dependent on the type of loan, the lender, the use of the funds, the borrower’s credit history, the business’s annual revenues, and the amount of the loan. When shopping for the best small business financing option, repayment terms are one of the most important factors to consider because they affect how long you will be paying on the debt. Borrowers that have better credit scores have more negotiating power when it comes to repayment terms, but any individual can ask for better small business loan terms during the application process. 

Shorter repayment terms may benefit your small business if:

  • You own a startup company or are a new business owner and expect annual revenues to significantly increase in the next 12 – 24 months.
  • You’re interested in using short-term business loans to improve your business credit score.
  • Your business needs a one-time influx of cash to purchase inventory in bulk or launch a new marketing campaign.
  • If your loan agreement has a high interest rate, paying the loan off early will save you money.

Longer repayment terms may benefit your small business if:

  • Cash flow is a concern, and your business would benefit from a smaller monthly payment.
  • The loan was used to make a large purchase, like with equipment financing or commercial real estate loans.
  • You plan to refinance the loan in the future when market conditions or the business has established more credit history.

Conclusion

Repayment terms tell a borrower how many payments will be required to pay off the business debt, so it is important to understand what typical business loan terms look like before beginning the loan application process. Loan terms depend on the type of loan, the lender, the amount of loan, and the borrower’s creditworthiness.

The best business loan for your business is one that has repayment terms that fit your business’s short-term and long-term financial goals. To explore different financing options and find the right repayment terms, reach out to Biz2Credit today. Marie Bibum worked with the experts at Biz2Credit to get approved for a small business loan that helped her keep operations going at her Washington D.C. pharmacy.

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