What Are The Different Types of Small Business Loans?
The three most common types of small business loans are term loans, revolving lines of credit, and non-revolving lines of credit.
Below is a brief description of each of the different loan types:
- Term Loans are typically used to finance long-term assets like automobiles, equipment, or commercial real estate.
- The payments include both loan principal & interest.
- These can have a fixed rate or variable interest rate.
- Term loans can be unsecured, but the collateral is usually the asset that is being financed with the loan proceeds.
Revolving Line of Credit
- Revolving Lines of Credit are typically used to finance short-term borrowing needs.
- For example, many businesses have to deliver their goods and services to their customers, then wait 30, 60, or maybe even 90 days to get paid.
- During this period, these businesses have ongoing expenses.
- A line of credit is helpful in covering the gap between when goods or services are delivered, and when a company receives payment from their customers.
- Payments are typically interest-only (kind of like a credit card).
- When the borrower collects the accounts receivable (or payment from their customers), the money collected is used to pay down whatever principal balance may be on the line of credit.
- Typically, a bank will set a credit limit (meaning the maximum amount that a borrower can borrow. Again, similar to a credit card.).
- The borrower then decides how much they want to borrow, and when (up to the credit limit of course).
- Revolving Lines of Credit usually have a variable interest rate.
Non-Revolving Line of Credit
- Similar to revolving lines of credit, non-revolving lines of credit typically have interest-only payments and variable interest rates.
- The primary difference is that non-revolving lines of credit are typically put in place to finance a single project (versus ongoing short-term needs).
- The borrower might have significant upfront expenses, with a large payoff at the end of the project.
- For example, a non-revolving line of credit could be used to finance crop production.
- In this scenario, a bank would give a non-revolving line of credit to a farmer at the beginning of the season.
- The collateral is usually the crop being produced.
- The farmer uses the non-revolving line of credit to pay for fertilizers, seed, and other pre-harvest expenses.
- Then farmer would then use the non-revolving line of credit to pay for the harvest expenses (labor, processing, packaging, etc.).
- After crop has been harvested and prepared for sale, it is sold to a buyer.
- The farmer is then paid by the buyer.
- After receiving payment, the borrower uses the money to pay off the non-revolving line of credit balance and takes the remaining money as "profit".
- At the beginning of the next season, the whole process starts all over again.
If you would like to know more about the different kinds of financing available to you and your small business, please give us a call. We would love to get to know you.
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