When the poet Paul Laurence Dunbar wrote about ‘years of regret and grief’ in his poem The Debt, he could have been speaking for the thousands of US small business owners who have taken out the wrong loan or agreed to unsuitable payment terms.
Yet, that's not far from reality. In fact, even applying for a small business loan – be it under installment or revolving terms – is still confusing for many.
Loans are essential to many businesses' growth and survival. Every company could use a helping hand now and then, especially entrepreneurs and small-to-medium businesses (SMBs). Acquiring additional funds is sometimes critical to their continuity, especially when a lack of cash flow occurs.
If you’re an SMB owner that has looked for financing before, you’ll know that choosing the right type isn’t easy. In the current economic climate, you’ll probably have grappled with the following issues:
Financial institutions like the Small Business Association (SBA), banks, credit unions, and online lenders are there to fund small businesses and help them close the gap when cash flow is low or customers are late on payments.
Choosing the correct type of small business loan (installing or revolving) depends on each one’s cash flow demands and repayment terms.
While both loan types can help a company considerably, choosing the best one for you might not be clear.
This article explains their characteristics and important differences, including
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The standard type of loan for small businesses is an installment loan, which provides a lump sum that businesses pay back according to a predetermined repayment plan.
Specific operational expenses, such as storefront signage, supplies, new equipment, the covering of an unforeseen expense, or the funding of operations during a slow period in business, are typical uses for this form of cash.
It’s essential for the loan’s objective to be pre-specified, not just to have money hanging around in cash, which makes no sense and can lead to misuse. However, there are many reasons to get an installment loan based on the nature and needs of the small business.
Similarly to how a home mortgage, student loan, or auto loan works, a small business installment loan gives a lump sum of capital followed by equal monthly payments with interest over a certain number of months, typically 12 but also 24, 36, 48, or 60.
According to Bank Rate, a print publisher for the banking industry, these are the top installment loan lenders as of December 2022.
Various financial institutions such as banks, credit unions, and online lenders offer installment loans, but each has its own criteria for eligibility. It is challenging for small businesses and startups to qualify for loans from banks and the SBA due to the strict requirements they impose. Therefore, this kind of small business loan funding might be denied in many cases.
To avoid this, it’s important to have a solid business plan, a certain number of years in business, a track record of business excellence, collateral, and a good credit score. Moreover, it often takes 60-90 days for a small business loan to get approved.
On the other hand, loans from online lenders, often known as online money platforms, have low minimum requirements that even startups might qualify for easily. And when it comes to timelines, online platforms are much faster and more upfront to understand. Many offer money within 24 hours with no FICO requirements, reasonable interest rates, and a one-minute application process.
No matter the lender, small company installment loans are typically broken down into subcategories based on the time it takes to repay the loan or the term. Typical installment loan categories include:
The large loan amount and subsequent repayment period make longer-term loans ideal for financing expensive investments like a corporate car or an office. Typically, the repayment period on such loans is six years or more.
These loans often have terms between two and five years, making them suitable for the expansion or equipment purchases of small businesses.
Loans with terms of fewer than two years can be used to make large purchases, close cash flow gaps, and maintain regular business operations.
According to Forbes Business Advisor, the FICO credit scoring algorithm places the most weight on your payment history when applying for an installment loan, accounting for 35% of your total score.
Making timely payments is a great way to improve your credit score. However, your credit score will be affected negatively if you consistently miss payments.
There are some distinguishing characteristics of small business installment loans:
The key benefit of an installment loan is the ability to quickly obtain a lump sum of money for a designated purpose. It provides a much-needed boost to firms, especially smaller ones, allowing them to take advantage of opportunities like refurbishing a building or buying expensive equipment.
In this regard, taxes can be a significant burden for smaller enterprises. The good news is that companies don’t have to pay taxes on the interest or principal payments on any loans they receive. As a bonus, the interest they pay may qualify as a tax write-off.
Monthly spending budgeting is a crucial step in removing cash flow uncertainty. Because of the fixed schedule of installment loans, businesses can easily plan and budget for loan repayments alongside other regular monthly business expenses.
Unlike other lending choices, such as payday loans, installment loans allow access to much larger sums of money. The size of the firm often determines the size of the installment loan. However, some internet lenders provide microloans as small as a few thousand dollars.
Some installment loans, such as those for restaurants, retail stores, new businesses, commercial real estate, and the healthcare sector, offer more favorable terms than others. Investing time into finding a compatible loan provider, then, is worthwhile.
A revolving loan or line of credit can be used as working capital (credit) to pay for operational expenses in a small business. This type of financing can come in the form of a line of credit, a trade line from a supplier, or, more popularly, a business credit card.
A revolving line of credit has a set amount limit, but can be utilized repeatedly as long as the account is kept active, and payments are on time. The major benefit is that the business only pays interest on the amount it borrows, and repayments are calculated based on this sum.
According to CDFA, the Council of Development of Finance Agencies, A revolving loan fund (RLF) is a “gap financing measure” utilized largely for the growth and development of small enterprises. It is a self-renewing fund that uses interest and principal payments on previous loans to fund the issuing of new loans.
While most RLFs help local businesses, others focus on specialized fields, like healthcare, minority business development, and environmental remediation.
As soon as the lender gives the go-ahead on the revolving loan, they will agree a limit with the business on how much credit they have access to. The business can then borrow money within that range during the loan term.
The borrower must make a payment at the end of each billing cycle. It can choose to either pay off the full amount it has withdrawn or make only the minimum payment, as determined by the lender, and "revolve" the remaining balance from month to month. Just the outstanding amount will be subject to interest charges.
For more clarity, suppose a small business borrows $10,000 on a revolving credit line, spends $4,000 in the first month, and pays back $2,000 in the same period. In that case, the revolving balance will be $2,000 plus interest, and the business will still have $8,000 in available credit.
According to Forbes Financial Advisor, these are the top business credit line lenders in December 2022.
There are two options for small business revolving loans: secured and unsecured credit. The primary distinction between the two types is whether or not collateral is required.
A secured revolving loan is a type of credit where the borrower pledges an asset or makes a security deposit to the lender to cover the loan repayment if the borrower defaults on the payments. The security deposit or collateral value is typically used as the maximum credit available.
Lenders like these loans because of the reduced risk they pose, but small businesses may not like putting their own assets up as collateral.
In contrast, the most prevalent form of revolving or line of credit loan is the unsecured loan, which does not require collateral and is more accessible to small businesses and startups.
In both cases, creditworthiness plays a significant role in establishing a cardholder's credit limit, and bad credit will have a great effect.
Revolving loans for small businesses have their unique benefits.
Interests on revolving loans for small businesses can be reduced by rewards and benefits, provided the company maintains good credit management and never goes into arrears. All sorts of things, from cash back to free plane tickets, are up for grabs if the company raises enough reward points.
Revolving loans are adaptable to changing financial needs since borrowers can access as much credit as they need rather than committing to a lump sum that must be used for a single large purchase.
A revolving loan eliminates the need for a lengthy loan application process every time it is repaid, the loan is kept open, and the business can continue using it.
For new and small enterprises, having access to revolving finance can provide peace of mind in the event of an emergency. The company can keep using the credit card or line of credit as long as they make the minimum monthly payments.
1. Revolving loans make monthly budgeting more difficult because they lack predictability
2. The incurred interest by making only the minimum payments will quickly add up
3. Compared to other types of loans, interest rates on revolving credit tend to be higher
4. The credit limit on revolving loans is typically lower than other loan amounts.
Understanding the differences between revolving and installment loans for small businesses is essential. These can be summarized as follows:
An installment loan provides a lump sum of money to be paid back over a fixed term, while a revolving loan lets the borrower access as much credit as they require within a predetermined credit limit.
Fixed monthly payments for an installment loan begin as soon as the money is released. However, with a revolving loan, the monthly payment is calculated based on the amount of money withdrawn, with a minimum payment required every month.
An installment loan provides a fixed interest rate and is based on the loan's principal amount, while the "Revolving balance" determines interest for a revolving loan. Therefore, it provides a variable interest rate.
The term of an installment loan is typically fixed and cannot be extended. However, the revolving loan can be adjusted and renewed as needed.
Standard installment loans include Small Business Administration (SBA Loans), equipment loans, business term loans, and microloans. The Small Business Administration (SBA) line of credit, business lines of credit, and business credit cards are all revolving loans.
When trying to figure out if an installment or revolving loan is best for your business, you should consider your company's financial conditions and how you plan to use the funds.
You’re more likely to reach the best conclusion by answering a few questions, including:
If your company has valuable property, machinery, or other assets that can be used as collateral, you may qualify for an installment loan.
Most lenders have stringent requirements for both personal and commercial creditworthiness. A large sum of money for a sizable purchase is the best use of an installment loan.
Here are several additional scenarios when the installment loan is better:
Payroll and other operating expenses can quickly deplete a small business owner's cash reserves, so if this affects your business, it makes sense to have a reserve of accessible credit.
Here are several additional scenarios when a revolving loan works better:
It may be that you, as a business owner, might not be able to fulfill the stringent requirements of the installment loan or the revolving loan.
To varying degrees, both types of lenders require a good credit score, collateral, and a track record of success.
Even the fluctuating interest rates and related costs that come with revolving loans present a challenge to many small businesses, despite their convenient payment structure.
Yet, there is a third option. A new wave of digital platform lenders offers a quick and simple way to get the money you need. You can apply for this finance quickly and easily, with no FICO requirements and affordable interest rates.
With applications taking less than a minute, these lenders use AI-powered credit scoring models to find the right lending option for your business within 24 hours.
Approval rates are much higher than traditional lending methods because they assess your business’s value far beyond its bank statements and credit score.
Considering that traditional loans decline over 80% of funding requests, this new world of digital finance may be the source of financing your business has been crying out for.
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