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Business Loan Agreements: What to Know Before Signing

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If this is your first time taking out a business loan, you might not know what to look for when it comes to the terms of your loan and the basics that it should include. There are a few things you should look for in your business loan agreement that you need to confirm before doing anything else.

In an ideal situation, you’d have a lawyer to help you go through the agreement; but if not, don’t worry. You will just have to be that much more careful about making sure you’re aware of what’s in the business loan agreement that you’re about to sign. While we certainly can’t replace a lawyer and cannot give legal advice, we can help you be as educated as possible when it comes to understanding your loan agreement.

What is a business loan agreement?

A business loan agreement is a document that holds all of the logistical details of business debt that a borrower is about to take on.  Reviewing your business loan agreement before signing on the dotted line is an absolute must. Otherwise, you’re taking on a business loan with terms that you aren’t even aware of.

This is far from an exhaustive guide–and every business loan agreement will have different features to look out for–but what follows are some of the most important things to look out for. We’ll go into each one in more detail below.

What does a business loan agreement include?

If this is your first time taking out a business loan, you might not know what to look for when it comes to the terms of your loan and the basics that it should include. There are a few things you should look for in your business loan agreement that you need to confirm before doing anything else.

1. Loan amount

For starters, you’re going to need to confirm that you’re signing on to borrow the business loan amount that you think you’re agreeing to borrow. Although it’s unlikely that your business loan agreement will have a different loan amount than previously discussed, this should be your first point of reference when reviewing it.

2. APR

Once you’ve checked out the loan amount, the next thing for you to do is check on the loan’s APR. The loan’s APR will measure how much it will cost you every year that you’ll be repaying it, interest and fees included.

Your loan’s APR should be your point of reference for beginning to grasp how much your business loan will end up costing you. It’s actually a more accurate measure for determining your loan’s cost than the interest rate. Even a decimal of difference in your loan’s APR could end up changing your loan’s cost drastically. Sometimes a business loan agreement won’t explicitly state your APR. Instead, you could be quoted an interest rate or a factor rate, which you should then convert to APR to understand the true cost of capital.

3. Repayment term

Now that you know your APR and the loan amount, check on the length of your loan’s repayment term. This will influence how much your loan will end up costing and how much your regular payments will be.

4. Total loan cost

The last fundamental to confirm should check out if the first three did, but your total loan cost is certainly worth triple-checking. The total cost of your loan should be a result of your loan amount, your loan’s interest rate, and your loan repayment term length.

5. Prepayment penalty

In addition to the basics we covered above, there’s more you’ll want to check out before signing a loan agreement. You should check if your loan comes with a prepayment penalty, which you would have to pay if you pay off your loan ahead of schedule.

Though it might feel like an arbitrary punishment for being financially responsible, a prepayment penalty compensates for the lost value that the lender might suffer due to your avoiding interest by paying off your loan early.

Not all loans come with prepayment penalties; but if they do, it’s crucial to know before you sign on.

6. Penalty fees

“Penalty fees” is a blanket term that can change in meaning from one business loan agreement to another. Penalty fees come in different amounts and apply to anything a particular lender defines as a penalty. This could be any action that breaches the terms outlined in your business loan agreement, like a late payment.

Be sure to check in on how your potential lender defines “penalty” in your business loan agreement, and then see how much you’ll be charged if one of these penalties occurs.

7. Definitions of default

This is one detail that you will definitely need to verify. Generally speaking, defaulting on a loan just means not paying it back as determined by the business loan agreement.

However, a lender can take this as literally or as loosely as they deem appropriate. For instance, not all business lenders will claim you’ve defaulted on your loan if you’ve missed one or two payments. On the other hand, some lenders will take a single missed payment very seriously.

If you “default,” then your lender can technically pursue legal action against you and collect on what they’re owed. With so much potentially at stake, be sure you understand how your lender defines “default” in your business loan agreement.

8. Type of interest rate

Whether it’s fixed interest or variable interest, your business loan agreement should delineate the details of what type of interest rate you’re agreeing to. Plus, if it’s variable interest, the business loan agreement should go into further detail about when exactly the rate will change.

Remember, your interest rate does not capture the full amount your loan will cost you. It’s crucial to go beyond the interest rate and calculate your APR to understand the true cost of borrowing.

9. Late payment fees

Next, you’re going to need to check on what late payment fees your lender will be charging you if you make a payment behind schedule.

Plus, you should see if your lender allows for any grace period for loan payments and, if so, how long it is. These are all questions that your business loan agreement should answer concretely and definitively.

10. Payment schedule

To make sure you never miss a payment, check on the payment schedule and be sure it’s what you agreed to when negotiating the loan in the first place. Whether your payments are daily, weekly, monthly, or otherwise will determine how quickly you pay off your loan and how expensive it will end up being. The schedule of your payments determines how much each payment will be.

To state the obvious, being certain about your payment schedule will allow you to avoid any late fees or penalties as well.

Business loan agreements: Terms to know

Most of the words and phrases in your business loan agreement will have incredibly specific meanings. While you might think you have a general idea of what the acronyms and phrases mean, it’s important that you have a firm grasp on all the loan terminology so that you know exactly what you’re getting yourself into.

Though this list won’t cover every single word you might come across in your business loan agreement’s fine print, it includes the definitions of many common loan terms that could potentially throw you off and even end up costing you.

ACH

Also known as “Automatic Clearinghouse,” ACH is a form of loan repayment that draws your loan payments, whether they be daily, weekly, or monthly, directly from your business’s bank account.

Amortization

“Loan amortization” refers to the way in which loan repayments are structured. If your loan amortizes, you’ll repay your loan through equal, scheduled repayments that are most often on a monthly basis.

Though these payments will always be equal in value, they will include different parts of interest and principal repayment with each payment you make.

What does that mean, exactly? It just means that, as you continue to pay your monthly loan payments, they’ll be the same amount, but that amount will be paying back less and less interest and paying back the principal debt more and more.

APR

Annual percentage rate, most often referred to as “APR,” is a way to indicate how expensive borrowing money will be. APR is denoted in a percentage that indicates how much a loan will actually cost you every year for the term of the loan.

Balloon payment

A balloon payment is when you pay off the principal debt that you owe in one huge lump sum at the end of the life of the loan. Throughout the life of the loan, if you have a balloon payment, your regular payments will only cover the cost of the loan’s interest.

Blanket lien

A blanket lien gives the lender a right to all of the borrower’s assets if the borrower defaults on a loan. Essentially, a blanket lien means that if you default on your loan, your lender could seize your property until the value of the loan is made up for.

Co-signer

If you have a co-signer for a loan, your co-signer will have to pay off the loan if you aren’t able to. Think carefully before you ask someone to co-sign or you agree to co-sign.

Curtailment

“Curtailment” essentially means “paying more for your loan than your pre-planned loan payment.” If you perform a partial curtailment, you’re able to pay more toward your loan than you expected, but you don’t pay your loan off in full. A full curtailment, on the other hand, means you pay off your loan in full.

Default

To default on a loan means you don’t pay the loan back according to the loan’s agreement. If you default on a loan that you legally agreed to, the lender can take legal action against you and your business or if you have a co-signer, they could also be on the hook.

Deferred payment loan

A deferred payment loan is when the borrower and the lender arrange an agreement that allows the borrower to begin payments at a specific time in the future rather than immediately.

Factor rate

A factor rate is how a merchant cash advance or sometimes how a short-term loan is paid back. Typically expressed as decimals, factor rates will let you know how much you’ll need to repay in total. For instance, if your loan amount is $100,000 and your factor rate is 1.18, you’ll be repaying $118,000 in total.

Interest-only payment loan

The interest-only payment loan is an alternative to the traditional amortizing loan. Throughout the loan’s life, your regular payment will just be a decided-upon portion of the interest that your loan will acquire.

At the end of an interest-only loan, borrowers will either pay the principal sum off in full or refinance it with another loan.

LTV ratio

Standing for “loan-to-value ratio,” a loan’s LTV ratio denotes how much of the value of an asset a loan will cover. This will be particularly pertinent to business owners securing equipment financing or commercial real estate loans because they will need to know how much of what they want to buy with the loan will be covered by the loan.

Loan underwriting

“Loan underwriting” essentially means the process that a lender goes through to assess how much of a risk a particular borrower is. The underwriting process will determine both if you qualify for the loan and under what loan terms you qualify.

Prepayment penalty

This is an important phrase to look out for in your business loan agreement—if your business loan has a prepayment penalty, you’ll still have to pay interest, even if you pay the loan off early.

Essentially, when you schedule your payments for a loan, you’re promising the lender a specific amount of value in interest that they’ll earn. If you pay your loan back early, the lender will get cut off from the interest that you would have left to pay. That’s why many lenders attach prepayment penalties to their business loan agreements.

Principal

Principal basically means the amount you borrowed, not including interest. If you borrowed $100,000 for your business, then your principal is $100,000.

Refinancing

Refinancing debt is the act of paying off one loan with another one. Borrowers can refinance loans with other loans that offer better terms.

Servicing

Loan servicing refers to the day-to-day of handling a loan. Payment disbursement, record maintaining, collections, and following up on delinquencies all fall under the term “loan servicing.”

Business loan agreement red flags

If in going through your loan agreement, you’re having some second thoughts about the lender, that’s an important feeling to consider. Red flags can be spotted in even the smallest of details, especially when it comes to business loans.

Before you sign that business loan agreement, let’s go over some worst-case-scenario warning signs that you might be about to sign on to a questionable loan:

Requesting money up front

If your lender is requesting you to pay money up front, this could be a sign of an untrustworthy lender. Even if they cite a specific purpose for the payment—be it a credit check, an application fee, or a brokering fee—a request for a one-off, up-front payment is a sign of shady practices.

Guaranteeing your approval

If your lender guaranteed you a loan before even seeing your business’s credentials, you could be dealing with a questionable lender. If your direct point of contact with this lender was a guaranteed offer, then you might be on the verge of signing onto a loan scam.

High-pressure sales tactics

Did you feel pressured into pursuing this loan? You might have gotten this far in the process simply because you felt like you couldn’t say no.  Take a moment or two to consider whether you’re really ready to take on debt with the terms laid out by the business loan agreement. If not, simply don’t sign.

Terms too good to be true

Lastly, if you’re signing a business loan agreement that delineates terms that are just too good to be true, then, unfortunately, they probably are.

Be sure to compare the business loan agreement terms to other offers to see if any are comparable. If the terms of the business loan agreement that you’re about to sign are in a league of their own, then you should probably double down on verifying the credibility of your lender before signing.

Frequently asked questions

What is a business loan agreement?

A business loan agreement is a document that contains all of the details regarding the debt that a business is going to take on from a lender—including the amount, terms, interest rate, and more.

The business loan agreement is signed by both parties—and in doing so, the lender is agreeing to lend money, and the borrower is agreeing to pay that money back.

What’s the difference between a business loan agreement and promissory note?

Although promissory notes and business loan agreements are similar, business loan agreements are typically more detailed and require the signature of both the borrower and the lender—whereas promissory notes usually only require the signature of the borrower.

In other words, a promissory note is a document that spells out your promise to repay a loan—but doesn’t give much more information. A business loan agreement, on the other hand, includes all of the details that are involved in the borrowing contract between you and the lender.

What is included in a loan agreement?

Although it will likely vary based on the type of loan and individual lender, most loan agreements include:

  • Loan amount, interest rate, term length

  • Total cost of the loan

  • Additional fees and prepayment penalties

  • Payment schedule

  • Default policy

  • Effective date

  • Signatures

The bottom line

With all of those steps covered, hopefully, you’re feeling good about the business loan agreement in front of you.

Remember to always consult an expert when making big financial decisions like this; but if you’re eager to take the first steps on your own, this guide can help you do it.

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Banking

Are Small-Business Loans Installment or Revolving?

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A small-business loan provides funds to purchase supplies, expand your business and more. This type of funding can be either installment or revolving. Reviewing the credit terms of your loan offer will help you determine whether you’re being offered an installment loan or revolving credit.

Both types of loans can be found in the Small Business Administration, or SBA, loan program and at banks, credit unions and online lenders. While each can provide much-needed funding for your business, there are some key differences to keep in mind.

Installment loans vs. revolving credit

Installment loans provide a lump sum of money

An installment loan is a credit agreement where the borrower receives a specific amount of money at one time and then repays the lender a set amount at regular intervals over a fixed period of time. Typically, each payment includes a portion for interest and another amount to pay down the principal balance.

Business term loan is another common name for this type of loan. After the loan is paid off, the borrower typically must apply for a new loan if additional funds are needed.

Revolving credit provides flexible funds

A revolving loan is a credit agreement where the borrower can withdraw money as needed up to a preset limit and then repays the lender a portion of the balance at regular intervals. Each payment is based on the current balance, interest charges and applicable fees, if any. You pay interest only on the funds that you use — not the maximum limit.

A business line of credit is a common type of revolving credit. Revolving credit gives the borrower flexibility in determining when to withdraw money and how much. As long as the credit balance remains within the preset limit and you continue to make timely payments, you can continue to draw from the line again and again.

Differences between installment loans and revolving credit

The terms of a loan can vary depending on the type of loan, lender and your business’s credentials. Your loan may be a unique combination of terms. However, the following are some common differences between installment and revolving loan programs.

Installment loan

Revolving credit

Loan amount

Fixed amount.

Maximum limit.

Withdraw as needed.

Payment amount

Fixed amount.

Minimum amount based on balance and interest with option to pay more.

Interest calculation

Based on loan amount.

Based on current balance, not maximum loan limit.

Ability to renew

Not renewable, typically.

Renewable, typically.

  • SBA loans.

  • Business term loans.

  • Commercial real estate loans.

  • Equipment loans.

  • Microloans.

  • SBA lines of credit.

  • Business lines of credit.

  • Business credit cards.

When to use an installment loan

Set loan amount is needed

If you’re confident in the loan amount you need, then an installment loan may be the right fit, especially if you need the money in a lump sum. For example, if you’re using the funds to make a one-time purchase, you’ll likely want an installment loan.

Long-term financing needs

Some term loans can offer you more time for repayment when compared with revolving credit. When you stretch your payments out over a longer period of time, it can mean a lower monthly payment. However, that trade-off typically means you’ll pay more in interest costs over the life of the loan.

Larger funding needs

If you’re looking to purchase property, equipment or other large-ticket items, there are a number of installment loans that can be used for this purpose. Revolving credit limits are often less than term loan maximums.

Preference for predictable payments

With a set monthly payment amount, it can be easier to budget for an installment loan compared with a revolving loan, where the payment varies depending on how much of the credit line you use.

When to use a revolving loan

Short-term financing needs

Revolving credit can be good to handle short-term cash shortages or to cover unexpected expenses. Some businesses use lines of credit as an emergency fund of sorts since they’ll pay interest only on the funds they use.

Fluctuations in cash flow

Businesses that experience major fluctuations in their cash flows may benefit from revolving credit. For example, seasonal businesses that don’t have consistent revenue throughout the year can use lines of credit to cover operational costs during their slow season.

Preference for flexible loan amount and payments

If you don’t know exactly how much money you need, then revolving credit will give you the option to qualify for a maximum amount but only withdraw funds as you need them. This way, you’ll pay interest only on the current amount owed.

Compare small-business loans

To see and compare loan options, check out NerdWallet’s list of best small-business loans. Our recommendations are based on the lender’s market scope and track record and on the needs of business owners, as well as rates and other factors, so you can make the right financing decision.

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Banking

Advantages and Disadvantages of a Business Bank Loan

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According to the Federal Reserve’s 2021 Small Business Credit Survey, banks remain the most common source of credit for small businesses — compared with options such as online lenders, community development financial institutions or credit unions.

You can use a business bank loan for a variety of purposes: working capital, real estate acquisition, equipment purchase or business expansion. To qualify for one of these small-business loans, however, you’ll likely need excellent credit and several years in business.

Before applying for a business loan from a bank, consider the following advantages and disadvantages.

Advantages of business bank loans

Flexible use of funds

Banks offer a range of different business loan products, including term loans, business lines of credit, equipment financing and commercial real estate loans, among other options. Unless you opt for a product that has a specific use case, like a business auto loan, for example, you can generally use a bank loan in a variety of ways to grow and expand your business.

When you submit your loan application, the bank may ask you to identify a purpose for the financing to evaluate the risk of lending to your business. Once you’re approved, however, the bank is unlikely to interfere if you change your intentions, as long as you make your payments. This flexibility is perhaps one of the biggest advantages when comparing debt versus equity financing.

Large loan amounts and competitive repayment terms

Bank loans are often available in amounts up to $1 million or more. Many online lenders, on the other hand, only offer financing in smaller amounts. Popular online lenders OnDeck and BlueVine, for example, both have maximum loan limits of $250,000.

Business loans from banks also tend to have long terms, up to 25 years in some cases. These loans usually have monthly repayment schedules, as opposed to daily or weekly repayments.

In comparison, online business loans typically have shorter repayment terms, ranging from a few months to a few years. Many of these loans require daily or weekly repayments.

Low interest rates

Banks typically offer small-business loans with the lowest interest rates. According to the most recent data from the Federal Reserve, the average business loan interest rates at banks range from 3.19% to 6.78%.

Although some online lenders can offer competitive rates, you’ll find that their products are generally more expensive than bank loans, with rates that range from 7% to 99%.

The interest rates you receive on a bank loan, or any small-business loan, however, can vary based on a number of factors, such as loan type, amount borrowed and your business’s qualifications, as well as any collateral you provide to back the loan. In general, the stronger your qualifications and the more collateral you can offer, the better rates you’ll be able to receive.

Relationship with a bank lender

Many banks provide ongoing support for their lending customers, such as business credit score tracking or a dedicated relationship manager to work with your business. Most banks also offer other types of financial products, such as business checking accounts, business credit cards and merchant services, if you prefer to use one institution for your financial needs.

Although some alternative lenders offer additional support and services, the Federal Reserve’s 2021 Small Business Credit Survey reports that businesses that receive financing are more satisfied with their experience with small banks (74%) and large banks (60%) compared with online lenders (25%).

Disadvantages of business bank loans

Intensive application process and slow to fund

To apply for a small-business loan from a bank, you’ll need to provide detailed paperwork that may include, but is not limited to, business and personal tax returns, business financial statements, a loan purpose statement, business organization documentation, a personal financial statement form and collateral information. You may have to visit a bank branch and work with a lending representative to complete and submit an application — although some banks offer online applications for certain business loan products.

The entire process, from application to funding, can take anywhere from several days to a few weeks, or even longer, depending on the type of loan and the bank. Some banks will also require you to open a business checking account with them before you can receive funds.

In comparison, alternative lenders typically have streamlined, online application processes that require minimal documentation. Many of these lenders also offer fast business loans — in some cases, funding applications within 24 hours.

Strict eligibility requirements

To qualify for a business loan from a bank, you’ll generally need strong personal credit (often a FICO score of over 700), several years in business and a track record of solid business revenue. Bank of America, for example, requires a minimum annual revenue of $100,000 for unsecured term loans and a minimum annual revenue of $250,000 for secured term loans.

Depending on the bank and the loan type, you may need to provide collateral, such as real estate or equipment, to secure your financing. Most banks will also require you to sign a personal guarantee that holds you personally responsible for the debt in the event that your business can’t pay.

Online lenders, on the other hand, have more flexible qualifications and some will work with startups or businesses with bad credit. To qualify for a business line of credit with Fundbox, for example, you only need six months in business, a credit score of 600 or higher and at least $100,000 in annual revenue.

Although online lenders may still require a personal guarantee, they’re less likely than banks to require physical collateral.

Find and compare small-business loans

Still trying to determine the right way to finance your business? Check out NerdWallet’s list of the best small-business loans for business owners.

Our recommendations are based on the market scope and track record of lenders, the needs of business owners, and an analysis of rates and other factors, so you can make the right financing decision.

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Finance & Accounting

What Are Typical Small-Business Loan Terms?

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Small-business loan terms determine how long a small-business owner has to pay back their borrowed money, plus interest. Typical loan terms, also referred to as repayment terms, can vary from a few months to 25 years — it depends on your lender and the type of business loan.

You and your lender will establish a repayment schedule that shows how much you’ll pay per week or month. While reviewing repayment terms, consider eligibility requirements and annual percentage rates, which take into account interest rates and other fees associated with the loan.

Typical loan terms overview

Repayment term

Term loans

Up to 10 years.

Business expansion.

Microloans

Up to six years.

Startups and businesses with smaller funding needs.

Up to 25 years.

Small businesses with good credit and available collateral.

Business lines of credit

Up to five years.

Short-term, flexible financing.

Invoice financing

A few months.

Cash advances based on unpaid invoices.

Equipment financing

Up to 10 years.

Equipment purchases.

Business loan repayment terms

Term loans: Up to 10 years

Small-business term loans provide a lump sum of cash upfront that borrowers pay back over time. Online lenders and traditional banks offer them, and maximum amounts range from $250,000 to $500,000. Term loans fall into either the short-term or long-term category — for example, a long-term loan may have a repayment term of 10 years while a short-term loan from an online lender might only give the borrower from three months to two years to pay it back.

Microloans: Up to six years

Nonprofit, community-driven lenders offer microloans to small-business owners in specific regions and underserved communities. While smaller loan amounts typically mean shorter repayment terms (and this is true for some microloans), SBA microloans have terms of up to six years.

SBA loans: Up to 10 years for working capital and fixed assets; up to 25 years for real estate

SBA loans range anywhere from thousands of dollars to $5 million and generally have low interest rates. The maximum 7(a) loan term for working capital is 10 years, although according to the SBA, seven years is common. Borrowers have up to 25 years to pay off loans used for real estate.

Business lines of credit: Up to five years

With a business line of credit, small businesses pay interest only on the money that they borrow, and funds can be available within days. Some business lines of credit require weekly repayments instead of monthly repayments.

Invoice financing: A few months

Invoice financing provides businesses with a cash advance while they wait on their unpaid invoices. Like a business line of credit, invoice financing is a quick way to access cash and is one of the shortest-term financing options available. Terms mostly depend on how long customers take to pay their invoices.

Equipment financing: Up to 10 years

Equipment financing is used to pay for large equipment purchases, and then that same equipment serves as collateral. Terms vary and usually depend on how long the equipment you’re financing is expected to last.

What is a loan maturity date?

A loan repayment term describes how much time you have to repay the loan, plus interest; you might also hear this referred to as loan maturity. This is not to be confused with the loan maturity date, which is the final day of your repayment term. On the loan maturity date, the entirety of the loan and any extra associated costs should be paid.

What is a prepayment penalty?

Some lenders charge borrowers a fee for paying off their loan ahead of schedule. Typically, this is to offset the lost interest the lender expected to receive over the full term of the loan. For example, SBA borrowers with a 15-year-plus loan term are penalized for prepaying 25% or more of the loan balance within the first three years of their loan term. Check your business loan agreement to see if your lender charges this type of fee.

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