Borrowing money is all part of growing a company. After all, 70% of small businesses have some sort of business debt, according to the 2019 Small Business Credit Survey conducted by the Federal Reserve banks, which includes 6,614 responses from small employer firms with 1–499 full- or part-time employees in the U.S.
But borrowing money does have a cost, so you shouldn't take on debt unless there's a clear benefit for doing so. To help with your financing plan, read on to discover the right times to get a business loan as well as how you can figure out the best way to borrow.
When Is the Best Time to Apply for a Loan?
- You see an opportunity to expand your business. If a business loan will help grow your future revenues, that's a smart time to borrow. This could be by hiring new staff, launching a new marketing campaign, developing a new product or expanding to a new location. Fifty-six percent of business owners that applied for a loan did so for this reason, the most popular response in the Small Business Credit Survey.
- You want to replace, repair or upgrade equipment. The cost of new equipment, vehicles and other business assets can be difficult to finance out of your existing cash, so borrowing makes sense to cover these investments. You could also put up the new assets as collateral for the loan to get a lower interest rate.
- You'd like to refinance existing debt at better terms. If you've already borrowed for your business, you may be able to qualify for better terms today. Perhaps market interest rates have dropped or your credit score improved since you first borrowed. By refinancing to a better rate, you'll have a lower monthly payment while still covering your debt.
When Not to Borrow
- You're having trouble with current debt payments. If your business already has trouble paying off its current debt, borrowing more may not be a good idea and could just dig you into a deeper hole.
- You aren't sure whether you'll use the money profitably. For business loans to make sense, the return on your investment should be higher than the borrowing cost. If you don't think your profits will grow by more than you'll end up paying in interest, then it might not make sense to borrow.
- You don't have an immediate plan to spend the money. Since a business loan charges interest each month, you want to put that money to work, not sit in the bank unused. If you aren't sure how you'd immediately invest the loan funds, hold off until you have a plan.
Evaluating Your Borrowing Need
If you've decided the time is right for taking out a business loan, you then need to evaluate how much to borrow. First, look at your business plan and financial statements to see how much money you could use to invest in your business. Add up all their potential costs to estimate the size of your ideal loan.
In reality, you may not be able to afford this entire amount. You should also look at your budget to see how much your business could reasonably cover per month for loan payments. Depending on the borrowing cost, this could restrict how much you could take out.
Finally, consider whether your business will need to borrow again in the near future. In this case, you may want to take out a smaller loan today so you're in better shape to qualify later. Having less outstanding debt will help improve your chances on the future application and successfully paying off a small loan now will also add points to your credit score.
Using a Business Loan Calculator
An online business loan calculator could help you evaluate your borrowing need. With this free tool, you can enter in different loan terms—like the interest rate, loan size and length of time to pay off the debt. The calculator will estimate how much you'd owe in monthly payments and show roughly how much it would cost to borrow, in terms of total interest. By playing with this tool, you can fine-tune your decision and figure out the right amount for your business loans.
Deciding on the Type of Business Loan
Finding the right fit for your business loan is a matter of several tradeoffs:
Fixed term or line of credit? A fixed term loan gives out a single, lump sum payment that you pay off over a set schedule. Once you pay off the debt, the loan ends. With a line of credit, you have the option to pay off the debt and then borrow again at your convenience. A line of credit may charge a higher interest rate than a term loan but gives you the flexibility to take out money again without submitting another loan application.
Borrowing money does have a cost, so you shouldn't take on debt unless there's a clear benefit for doing so.
Secured or unsecured? You back up a secured loan with some sort of collateral—like equipment, a vehicle or a piece of real estate. If you fail to pay off the loan, the lender can take your collateral. In exchange, the loan will charge a lower interest rate. With unsecured loans, you'll pay more to borrow but won't have to worry about risking a valuable business asset.
Fixed or floating rate? Fixed loans always charge the same interest rate so your monthly payments do not change. This creates a more predictable budget. Under a floating rate business loan, the amount you pay each month can change depending on a benchmark rate. Your monthly payments could go up or down depending on the market.
Credit is available for your small business so make sure to put it to good use. By keeping this information in mind, you can come up with an effective borrowing strategy and set up the right loan at the right time.
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