Whether starting or expanding your business, you may need financing for your business goals. Many small business owners turn to financial institutions like banks or lenders that offer loans as capital without losing equity or stake in their company. However, with so many lenders trying to get their hands on funding, some business owners often make mistakes when financing their businesses.
In this article, we’ll look at seven small business loan mistakes that can cost you money in the long run.
What is a small business loan?
Small business loans are loans generally taken out to finance the purchase of an asset such as equipment or a car to help with your business’ working capital. In general, you can borrow any amount starting from $5,000 up to $1,000,000 which can be repaid between one and seven years. Depending on the type of loan you’re applying for, the amount of the loan, the repayment loan term, interest rate, type of interest rate (fixed rate or variable interest rate), and other fees will vary.
You also have the option to choose between a secured or unsecured loan. Secured loans are the type of loans that require some type of collateral as a condition, such as a house or a car. The asset’s worth must also be at least equivalent to the loan amount. Unsecured personal loans are the most popular loan type used by borrowers and they are not backed by any collateral. Since unsecured personal loans are riskier for lenders, they may have higher interest rates.
Lenders charge interest on loans based on a customer’s credit score and repayment capabilities. The rate ranges from 5% to 36% and can be paid over one to seven years. You can select either a variable or a fixed interest rate. A fixed interest rate, which almost all lenders provide, is a constant rate charged on a loan. It applies for the duration of the loan and remains constant throughout. Variable interest rates, on the other hand, can fluctuate over time since they are dependent on a benchmark interest rate that changes regularly.
7 common small business loan mistakes
Here are 7 common mistakes small business owners make.
Lacking a Business Plan
One of the biggest mistakes that small business owners make is not having a business plan. A business plan is critical to managing a business and making sure it’s moving forward in the right direction. A strong business plan may help guide future decisions, but also current ones such as inventory level decisions or personnel hiring. Without a business plan, your chances of getting approved for a loan are much lower.
A business plan should be easy-to-follow, easy to understand, and easy to copy. It should also include a budget that shows how much money you have available to spend on your business, as well as how much more you need to get it off the ground.
Not Applying Honestly
If you want to get a loan, you need to be honest with your application. Some business owners lie on their applications to make their business look better. But, it will always backfire. If you do not get caught then you might end up having the trouble of not being able to repay the loan.
Limited Cash Flow
A small business owner looking for a loan will often ask for an unsecured loan. This means there is no collateral involved and the only thing the lenders will check is your ability to pay back the sum borrowed with interest. For unsecured loans, stable cash flow is an important factor for approval since there is no collateral involved
Poor Credit Score
Your credit score is an important part of getting a loan. When lenders look at your credit history, they will see how often you pay your bills on time. If you have a history of not paying bills on time or owing too much money, this can lead to them looking at your credit report and finding that you have a poor credit history. A score of 622 on Equifax indicates a good credit score. If you have bad credit, you can still get a loan. But how much you can borrow will only be limited to $2,000. Lenders will ask for your 90-day bank statements to ensure that you have enough money in your bank account to repay the loan.
Before approaching potential lenders, business owners should have their act together. That means having all the paperwork necessary for your business loan application on hand. Messy bookkeeping and inconsistent business practices, such as mixing business and personal bills or not filing tax returns, can prevent you from getting financing. If you’ve got the paperwork in order and aren’t missing any required documents, then you’re good to go.
Borrowing Beyond the Requirement
If you meet all of the lender’s eligibility requirements, you could be qualified for a much larger loan. It is only natural to be tempted to borrow more than what you initially planned.
This temptation, however, should be avoided because you may end up borrowing far more than you can afford to repay, leaving you in a financial bind. As a result, stick to the initial plan, borrow only what is necessary, and make sure you repay it on time.
Too Many Loan Applications
While applying for many loan applications may seem like a great way to get more money, it can hurt your chances of getting the loan you want. Going through too many cash loan applications at once can be a red flag for credit bureaus. That’s because they’ll see it as a sign that you’re trying to increase your borrowing capacity which could potentially affect your credit score.
Not doing enough research to find the right lender
Finding a lender could be so difficult that it’s tempting to go with the first one that comes up. However, seeking one loan source without first considering your other possibilities is a mistake. Take the time to research various traditional and alternative lenders to discover the best fit for your business.
How to avoid these mistakes
When you’re applying for a business loan, there are a lot of things to remember. Here are some tips to avoid making mistakes:
- Make sure your company can provide documentation of its financial situation
- Make sure that you have a good credit score. A good credit score is required to be eligible for the lowest interest rate on a business loan.
- Make sure you have a good business plan before going through the application process. This will guarantee that you get the most out of your loan and don’t end up paying more money than necessary.
- Keep track of your costs and ensure that they are within the limits of your budget.
- Keep track of all payments to avoid missing any deadlines! Make sure they are paid on time each month so that they don’t affect the amount of interest charged on top of them.
Benefits of small business loans
Small business loans provide cash when it is most needed. They can also be beneficial for small business owners who run a business with lower revenue during certain times of the year. During these times, a loan might help to keep your cash flow stable. In addition, as long as you make your monthly payments on time, a loan can also help you improve your credit score and also help you qualify for even better loan options in the future.
Small business loans are available to help you in getting the finances you need to meet your goals. They can be used to secure goods, purchase equipment, rent operational space, hire staff, or cover other expenses. However, several obstacles may prevent you from obtaining a loan. Therefore, you must have a strong business strategy, a stable and reliable history of financial stability, and good credit. If you meet all these criteria, you may be able to secure a business loan for your growing business.
Marjorie Hajim is the SEO Manager for Friendly Finance. Friendly Finance is a leading loan matching service in Australia specialising in consumer finance. She loves growing businesses with a focus on their online presence and is passionate about organic growth and all things digital. She has written articles for Coinpedia, MoneyVests, HomeBusinessMag, & many more!