The basics of business loans

The success of a business can depend upon how much money they borrow with a business loan. If you sensibly borrow money, your company can pay it back without paying too much in interest fees. If you borrow too much, you may have difficulties paying it back. Half of all small businesses fail within the first 12 months, which is why it is important to borrow only what you need to get started. There are several different aspects of business loans, this article will cover a few of the basics you need to know.

Lenders
There are several types of lenders you can use to obtain your business loan. Traditionally banks and credit unions are used to finance your business. Some businesses have investors that are willing to loan some of the money to get your business started. Sba.gov has detailed information on how to select the right type of lender to get your business started.

Once you select a lender, be prepared to sign a promissory note. This written agreement basically states how much money you will borrow and how much you will pay in interest. The promissory note discusses all the terms of the loans so you can hand it over to the IRS in case you are audited.

Understanding Interest
Every loan is designed to provide money up-front to you with a re-payment plan plus interest for the lender. This is a win-win situation since you and the lender both get the money you need. The interest with a business loan is normally pretty low compared to other loans. There are state laws that cap off how much money a lender can charge in interest. Typically business loans interest rates do not exceed 10 percent. The interest rates also change for private lenders and commercial lenders so you need to look up your state laws to see which ones have lower rates.

Collateral
When you apply for a loan, lenders normally ask that you put up some type of collateral. Normally the collateral is a piece of real estate or another security with value. The collateral is used to secure the loan in case you default the lender can collect the money you owe using your collateral. You can use a lien on your equipment or inventory to front as collateral if you do not have enough equity in your home.

Personal financial information
Quite often lenders will run a credit check and ask for your personal financial information in order to figure out what type of risk you are. If you are unable to control your personal finances, your lenders will be hesitant to loan you a great deal of money. Lenders will review your repayment to your existing lenders along with your debt to income ratio. To obtain the loan, your personal credit score must be around 720 or higher. Most lenders are even looking for higher credit ratings due to the poor economy.

Loan Guarantee
Most lenders will ask for a co-signer to guarantee the loan, especially if you have a lower credit score or you are unable to front some collateral. The co-signer assumes responsibility for the loan if you default on it. Banks prefer to have co-signers since it increases their chances of collecting on the loan. Since high businesses have high failure rates, lenders are naturally hesitant to give you the money without collateral or a personal guarantee. Even if you organize your business as a LLC, you forfeit your property if you default on the loan. The lender can even go after your spouse if you default on the loan. Some lenders actually insist that spouse's cosign on the loan if their property is at stake.