Avoid Overpaying for Your Small Business Loan
If you’re searching for small business funding, you’ll come across a dizzying array of options. From SBA loans to merchant cash advances to business credit cards, each type offers a variety of rates, terms and other factors that affect the overall cost.
How can you make sure you’ll get the right loan to grow your business and save money? No matter which loan product you go with, your goal should be to secure the lowest cost funds available for your particular business. We’ve outlined five six ways you can avoid overpaying for your small business loan.
1) Determine if your business is “loan ready” before you apply
Time is money! Save time before you apply for a loan by determining if your business is “loan ready.” Try the new SmartBiz Advisor™, an online, educational tool that helps you learn how you can get your business SBA or bank loan ready – no cost involved. By just answering a few questions about your business and uploading your most recent tax return, you’ll get your business’ unique “Loan Ready Score”* in just minutes. The Loan Ready Score, built by analyzing thousands of small business financials with our intelligent platform, helps you learn how your business stacks up to get a low-cost loan and educates you about the 7 key factors banks typically use to evaluate your business. Learn more about SmartBiz Advisor here.
2) Don’t wait too long to seek financing
Applying at the last minute when you really need money isn’t a great strategy. The application and approval process to get a small business loan can be time consuming. If you’re under the gun, you may be forced to settle for less-than-ideal options. Here are two ways to avoid stress and scrambling:
Monitor Cash Flow
Using a cash flow statement helps you track revenue inflow and expense outflow for a specific time period so you can anticipate when you’ll have money going out and coming in. The SmartBiz Small Business Blog has an in-depth post about this topic: How to Calculate Small Business Cash Flow.
It’s no secret that planning ahead is essential for business success. Financial forecasting is one tool to help you stay on track. Forecasting involves developing a comprehensive set of projected financial statements and can help you pinpoint when funds are needed. The Balance Blog has an excellent article to help guide your forecasting efforts here: Financial Forecasting for Your Small Business.
Best Strategy: Work with your accountant or another financial professional if looking at the numbers isn’t your strongest skill. You can also find help through the SBA at a Small Business Development Center.
3) Limit the number of loans you apply for
You might be tempted to apply for several loans with fingers crossed that one will come through. But some credit inquiries can lower your credit score while some don’t. Here’s what you need to know to avoid getting dinged during prequalification.
A hard inquiry, also knows as a hard pull, occurs when a lender checks your full credit history. Investopedia reports that the reason a hard inquiry may lower an individual’s credit score is because someone who has recently applied for new credit is seen as a potentially riskier borrower. A hard inquiry can lower your score.
A soft inquiry, also known as a soft pull, occurs when you check your own credit report, when you give a potential employer permission to check your credit, when financial institutions you already do business with check your credit and when credit card companies that send preapproved offers check your credit. You can see any soft pulls on your credit file when you check your own credit report. They will be under a subheading like “inquiries that do not affect your credit rating,” and you’ll see the requester’s name and the inquiry date. FYI: SmartBiz Loans™ performs a “soft pull” during the prequalification process that will not affect your credit score. A hard pull is done once the borrower is matched with a bank most likely to fund.
Best Strategy: Ask lenders about their credit check policies in advance so you’re not caught by surprise.
4) Borrow the right amount
When business owners consider borrowing funds, one of the most-asked questions is “How much should I borrow?” Borrow too much and you might struggle to pay the loan, crunching cash flow and possibly putting your business in jeopardy. Borrow too little and you may not be able to fulfill your business-building goals. If you hit the sweet spot, borrowed funds can drive increased returns on investments and add value to your business.
Before you approach a lender, use NerdWallet’s business loan calculator to determine your payments and the affordability of your small-business loan. Next, ask yourself if the loan will generate enough income so you can comfortably pay the loan back over time. Finally, determine your goals for the next year – where are you realistically headed in the future?
Best Strategy: Take a look at your business plan. According to the SBA, your business plan should project 3-5 years ahead and outline the route to take to reach milestones, including yearly revenue projections. A well thought out plan helps you step-back and think objectively about your business and helps with decision-making.
5) Avoid prepayment penalties
When you pay a loan off early, the amount of interest the lender earns on the loan is reduced, so some charge a penalty. The fee is usually a percentage of the outstanding balance of the loan. Prepayment penalties can also be calculated on a sliding scale where the earlier you pay, the higher the penalty will be.
Not all loans have this type of penalty built in. For example, SBA loans have no prepayment penalties.
Best Strategy: Read the fine print before signing the loan agreement so you understand exactly how much you will be charged for prepaying a loan. When shopping for a loan, you may be able to negotiate the removal or reduction of a prepayment penalty.
6) Determine the “True Cost”
Payday loans, merchant cash advances and other loan products like invoice factoring, obscure the ability of borrowers to determine the actual cost of financing. If you don’t read the fine print, it can be difficult to determine if the stated interest rate actually reflects the true cost of the loan. Business owners can end up paying much more than they realized and get stuck in a loan they can’t afford to pay. According to Leo Jacobo, VP, Head of Lending Operations for SmartBiz Loans, there is a relatively easy way for borrowers to discover the actual loan cost. That way is to determine the loan constant. Leo writes, “The loan constant is one of the oldest concepts in lending and used regularly by banks to calculate debt service burdens for both consumers and businesses. The loan constant reflects the full amount of cash required annually for debt service.”
Best Strategy: Compare “apples to apples” by factoring the loan constant when considering different types of loans. Multiply your monthly payment by 12, and then divide the figure over the original loan balance. The resulting percentage is the true cost of borrowing as it reflects the total payment, interest as well as amortization for loans that require principal pay down. Review this article for more information and specific examples: What Small Business Owners Need to Know About the Loan Constant.
Not sure if you qualify for an SBA loan? Try the new SmartBiz Advisor™ online, educational tool to learn about how you can get your business SBA or bank loan ready before you apply – no cost involved. You can assess key criteria banks consider and where your business stands on each. Learn more about SmartBiz Advisor here.
*What you need to know: The information provided through SmartBiz Advisor, including the Loan Ready Score, is for educational purposes only. SmartBiz Advisor is not a financial or legal advisor as defined under federal or state law. Use of this information is not a replacement for personal, professional advice or assistance regarding your finances or credit history.