Whether you’re starting a business or looking to grow, having access to funds can be a big help. If you’ve never applied for financing like business loans or a line of credit, you might be intimidated by the process.
Not to worry. We’re here to help you understand what you need to apply for the financing option you choose as well as understand the difference between a business loan and line of credit.
Let’s begin with the steps you’ll need to take.
Step 1: Assess Your Business Needs
Before you start shopping for business loans or a line of credit, start by determining what your needs are. How much money do you need, and what specifically will you use it for?
Decide whether you want to apply for a business loan or a line of credit. A business loan can be useful if you need a large sum all at once. Affordability might not match what you qualify for. Calculate how much you can afford to pay toward your loan payment each month before deciding to take out the largest loan possible. Just because you qualify for a bigger loan doesn’t mean it’ll be financially comfortable for you.
A line of credit can be handy if you need some money now and more down the road. You might find it useful to have access to funds over time, rather than getting it all at once.
Step 2: Check Your Creditworthiness
One of the criteria most lenders will consider is your creditworthiness.
Make sure your business is well-positioned to qualify for competitive interest rates and terms. The way to do this is to have financial commitments in the business’s name (utilities, trade accounts, a lease agreement, and so on) and pay all of your bills on time. You should also have a cash reserve. The more money you have set aside, the easier it is to qualify for credit. It may seem counterintuitive, since having cash could mean that you have less need for credit. But it’s important to show that your business isn’t operating paycheck-to-paycheck. The closer you are to the financial edge, the more risky you might look to lenders.
Personal creditworthiness is the measure many lenders will use for many small business owner applicants because not all small businesses have established business credit history.
The lender will look at your credit report. Your credit report reflects your experience with credit accounts, including any loans you have and whether you’ve made payments on time for your accounts. They’ll also look at your credit score, which is a numerical snapshot of the information on your credit report. Credit scores help lenders predict how likely it is that you’ll pay back your loan.
Lenders typically use your credit score to determine how much to charge you in fees and interest. The higher your credit score (or your business’s credit score), the lower the interest rates and the better the terms you’ll qualify for.
Your business might have a credit score and credit report if you’ve had a credit accounts in your business’s name. If so, the lender could evaluate your business’s creditworthiness separately from your personal creditworthiness. If your business has never taken out a loan, it may not have enough credit history to be considered.
Step 3: Research Potential Lenders
When it comes to business loans and lines of credit, look at banks, credit unions, and online lenders as options. Some may have more strict criteria for approval, while others may have faster application processes but higher interest rates.
Compare loan and credit line options, and narrow down the list based on the options you qualify for with the best rates and terms. Be sure to note any fees and additional costs a lender may charge.
Step 4: Prepare a Strong Application
Before you apply, ask what types of documents you’ll need. These may include income statements and balance sheets, tax returns, and a government-issued ID.
You may also need a business plan as part of your application. If you don’t have one, create one, as a solid business plan may help you get approved for financing.
Step 5: Review Offers and Terms
Check with lenders who can help you find out what you’ll qualify for without a hard pull on your credit. Hard pulls, or hard inquiries, almost always happen when you apply for new credit and they can temporarily knock a few points off your score. To avoid unnecessary credit score damage, it’s best to apply as little as possible.
Evaluate the offers you get during your research. Consider the interest rates, repayment terms, fees, and even customer service reviews of each option, to determine which lender you want to work with.
Step 6: Submit Your Application
Once you’ve chosen the loan and lender you want to apply for, find out what they need from you. Every lender has a slightly different application process. Most allow you to apply online.
You may be asked to provide additional documentation to support your application, so plan for extra time in the process.
You could get your decision in a few seconds or might have to wait for several weeks.
Step 7: Accept the Offer and Access Funds
To get your funds, you’ll need to sign the loan or credit line agreement. Read it carefully! It should have important information about the loan amount, fees, the interest rate, collateral requirements, the repayment schedule, what to do if there’s a dispute, and other details.
After you sign and return the loan agreement, most banks electronically deposit the funds into your bank account. This often happens within a week.
Business Loans vs. Lines of Credit
So which is better for you, a business loan or a line of credit? Let’s explore the differences.
Just like any other personal loan, student loan, or mortgage, a business loan works like this: A lender gives you a lump sum of money that you'll repay over an agreed-upon period. You'll pay interest on the amount you borrow, and you might also pay fees.
A business line of credit is a bit different. It works like a credit card. Rather than receiving a sum of money all at once, you're approved for a certain amount. You can use what you need when you need it, up to your limit. Once you pay back what you borrowed, it’s available again to borrow. Let’s say you’re approved for a $10,000 line of credit. You use $5,000 and pay back $2,000. You now have $7,000 you can borrow when you need it. There’s typically no end date for when you have to take the money out of your line of credit, but some lines of credit may have a draw period. In that case, you’d have a number of years during which you can borrow, and then you’ll enter a repayment period when you can’t borrow more.
Why Take Out Business Loans or Lines of Credit?
There are many benefits to having access to money through business loans or a line of credit. If you’re starting a business, you could use the funds to rent office space, buy furniture and equipment, and hire staff.
If you’ve been running your business for a while, you might be ready to grow, maybe by adding a second location or hiring staff. You might expand your product lines or invest in research and development. Business loans or a line of credit could help with that.
You could also use financing to cover marketing, whether that’s hiring a social media firm to amplify your online presence or investing in advertising.
Another benefit of having access to capital is to cover a slow period for your business. Some businesses are cyclical; they may do well in the summer, for example, but slow to a trickle in the winter. Having a business loan or line of credit can ensure that you’ve got the capital you need to cover expenses during the slow period.
If You Don’t Qualify for the Loan You Want Yet…
If you are turned down for a loan with a bank, consider shopping around with online lenders or local credit unions. You might find some with more flexible requirements.
If you find that you don’t qualify for terms you’re happy with, look for ways to improve your creditworthiness. You could pay down existing debt, put more money in savings, or open a small local trade account in the business’s name. After a few months, check loan offers again.
Taking out a business loan or line of credit could help your business reach new heights. Take your time to analyze your needs. Do your research to find the best business loan or line of credit that your business qualifies for. The time and effort you put in now could save you money in the long run.
Once you receive the funds, put them to work. Making a financial investment into your business is only worth it if you use the money to maintain or increase profitability. Make the loan payment on time every time to build a positive credit history for your business and enjoy your business’s time of growth.
