Stop Overpaying For Small Business Loans By Avoiding These Hidden Traps

The U.S. has nearly 27 million small businesses and around 80% of them use some form of credit to finance their operations, including bank loans and

credit cards.

Risk

These lines of credit can be vital to keep small businesses going, and do not usually require collateral, so long as the business is deemed credit-worthy by the lender. The loans will be limited by this assessment and will of course be repayable monthly with interest and fees, so it’s important not to over extend when it comes to borrowing.

Calling in the loan

During the last credit crunch, some banks asked small businesses to pay off their loans immediately and if they couldn’t do so, set up new payment plans with higher interest rates. Banks also are now subject to strict underwriting requirements before lending to small businesses, so other financial institutions may be a better bet.

The Good

Lending by small community banks has expanded hugely, and they will lend if convinced of the on-going profitability of a business and ability to repay the loan. Non-profit credit unions are also expanding their lending capacity, relaxing their membership rules and generally offering better terms than commercial banks. Factoring companies will often take over payment of invoice debts due to a business, and advance 80-90% of the sum owing within a few days. They then pay the balance less their fee of 3 to 6% when the invoice sum is collected. Often, if they can’t collect the debt within 12 months it will become immediately payable by the business, but this is a good way to keep cash flow going. The system works on the credit-worthiness of your debtors rather than on that of business. Sums receivable can also be used as collateral for a short-term loan with other lenders such as banks, but interest rates for receivables financing can be high. Inventory financing is another option that uses the business’ inventory as collateral for a loan, and can be suitable for firms that store high value items that don’t move quickly.

The Bad

Finance companies provide short terms loans to businesses, usually at exorbitant rates and with little regulation. They should only be a last resort and avoided if possible. Unsecured credit is another risky option, where loans are made to low-risk borrowers with high personal credit scores, even if the business is losing money. Commensurate with their risk, interest rates are likely to be very high. Some lenders can help retirement funds to be used as an investment for a business, without the need to pay interest, but obviously this has serious implications for retirement funding and should be done with extreme caution.