Small business loans can be a great way to get your business started or help it grow. However, there are a lot of different types of loans available, and it can be difficult to know which one is right for you. In this article, we will discuss some of the most common business loan terminologies you need to be aware of so you can make an informed decision.? Let’s get started!
What is Loan Terminology?
Business loan terminology can be confusing for small business owners. Business loan terminology is a set of words and phrases used in the lending and borrowing of money. The most common terms in a business loan agreement are principal, interest, maturity, and amortization.
Business Loan Glossary
A
Alternative lenders
These are lenders that are not traditional banks or financial institutions that offer alternative lending options like merchant cash advances. They may be online lenders, peer-to-peer lenders, or even family and friends.
Annual Percentage Rate (APR)
The Annual Percentage Rate or APR is the annual rate charged for borrowing, expressed as a percentage of the business loan amount. It includes the interest rate on the loan balance and other associated charges.
Amortization
The process of repaying a business loan in periodic installments. The installment payment includes principal and interest.
B
Balloon Payment
A balloon payment is a lump sum payment you make at the end of your business loan term. This type of payment is typically used when your loan has a shorter term than the amount of time it takes for your business to earn enough money to pay off the loan.
Bank Loans
A bank loan is a loan that is issued by a traditional bank or financial institution.
Borrower
The person or business who is borrowing money or taking out a business loan.
Borrower’s Monthly Payment
The periodic loan payment the borrower makes to the lender. Loan payments usually include interest and principal.
Bridge Loan
Bridge loans are short-term loans used to bridge the gap between the time a business needs money and the time it can get its hands on long-term financing. These loans are typically for six months or less.
Business Credit Cards
Business credit cards can be a great way to finance your business. They offer a variety of benefits, such as cashback rewards, travel rewards, and 0% APR introductory rates.
Business Line of Credit
A Business line of credit is a type of loan that provides your business with a set amount of money that can be used for any purpose. With a business line of credit, you can withdraw funds up to a limit set by the lender.
Business Loan Term
A business loan term is the amount of time for which a loan is valid. Generally, the loan term is less than the amount of time it takes for your business to earn enough money to pay off the loan.
Business Plan
A business plan is a document that outlines a company’s goals and how it plans to achieve them. It typically includes information about the company’s products and services, marketing strategy, financial forecast, and management team.
Business Loan Terms & Rates
The business loan term and rate refer to the specific details of the loan agreement. Typical business loan terms vary based on many factors but usually include the interest rate, repayment period, and any other associated charges.
C
Capital
Capital refers to the funds a business uses to start or grow its operations. It can be in the form of cash, equipment, inventory, or real estate.
Cash Flow
Cash flow is the movement of money in and out of a business. It can be used to measure a company’s financial health and performance.
Cognovit Note
A cognovit note allows the lender to take legal action against the borrower if they default on the loan. This type of note is typically used when the borrower is high-risk.
Co-borrower
A co-borrower is a person or business that cosigns a loan with the borrower. This means that they are equally responsible for repaying the loan.
Collateral
Collateral is an asset, such as property or equipment, that you use to secure a loan. If you default on your loan, the lender can seize the collateral and sell it to repay the debt.
Cosigner
A cosigner is someone who agrees to sign your loan with you. This person is typically a friend or family member who has good credit and is willing to help you get approved for the loan.
Credit Bureaus
Credit bureaus are organizations that collect and maintain information about a person’s credit history. This information is used to create a credit report, which is a document that shows a person’s creditworthiness.
Credit History
Credit history is a record of a person’s or business’ credit transactions and credit score. This information is used to create a credit report, which is a document that shows creditworthiness.
Credit Limit
A credit limit is the maximum amount of money a business can borrow with its credit card. It is important to stay within your credit limit, as going over it can damage your credit score.
Credit Line
A credit line is a type of loan that provides your business with a set amount of money that can be used for any purpose. It’s similar to a business credit card, but with a lower interest rate.
Credit Report
A credit report is a document that shows a person’s or business’ credit history. It includes information about the person’s or business’ credit transactions and credit score.
Credit Score
Your credit score is a number that represents your creditworthiness. It is used by lenders to determine whether or not you are a good candidate for a loan.
D
Debt Consolidation
Debt consolidation is the process of combining multiple debts into a single loan, often with more favorable terms such as a lower interest rate or more manageable monthly payments. This can be an effective strategy for businesses looking to simplify their debt management and potentially reduce overall costs.
Debt Instruments
Debt instruments are financial tools that businesses can use to borrow money. This includes things like business loans, lines of credit, and credit cards.
Debt-to-Income Ratio
A debt-to-income ratio is a calculation that shows how much debt a business has compared to its income. This number is used to measure a company’s financial health and risk.
Default
Default occurs when you fail to make payments on your loan according to the terms agreed upon. This can result in damage to your credit score, and the lender may take legal action against you.
E
Existing Loan
An existing loan is a loan that has already been approved and is currently in use.
Equipment Financing
Equipment financing is a type of loan that provides businesses with the funds they need to purchase equipment. This type of loan is typically used to finance large purchases, such as vehicles or industrial equipment.
Equity
Equity is the portion of a business’ ownership that is funded with the owner’s own money. It’s used as collateral for a business loan, and the lender can seize it if the borrower defaults on the loan.
Equity Financing
Equity financing involves raising capital by selling shares of your business to investors. Unlike debt financing, which requires repayment with interest, equity financing offers capital in exchange for ownership stakes, meaning investors gain a share of the profits but also bear some of the business risks.
F
Fair Market Value
Fair market value is the price that a buyer and seller agree upon when they are both acting in good faith. This price is typically used to assess the worth of a business or its assets.
FICO
FICO is a credit scoring system that uses a person’s credit history to determine their creditworthiness. It is used by lenders to determine whether or not to approve a loan.
Fixed Interest Rate
A fixed interest rate is a type of loan in which the interest rate does not change over the life of the loan. This means that the borrower knows exactly what they will be paying each month.
G
Grace Period
A grace period is a time during which a borrower is allowed to make payments on their loan without being penalized.
Gross Income
Gross income is the total amount of money a business makes before any deductions are taken out. This number is used to calculate a business’ debt obligations, which are the payments it must make on its outstanding loans.
Guarantor
A guarantor is an individual or entity that agrees to be responsible for the repayment of a loan if the primary borrower defaults. This is often required for businesses with limited credit history or for high-risk loans.
H
Hard Credit Check
A hard credit check is a type of credit check that is used to determine a person’s or business’ creditworthiness. This type of check is more rigorous than a soft credit check, and it can result in a lower credit score.
I
Interest Payments
Interest payments are the fees that a business pays to a lender to borrow money. These payments are typically calculated as a percentage of the loan amount and must be paid monthly.
Invoice Financing
Invoice financing is a type of loan that provides businesses with the funds they need to pay their suppliers. This can be used to finance large purchases, such as inventory or equipment.
L
Lien
A lien is a legal claim or right against assets that are typically used as collateral to satisfy a debt. If a borrower defaults on a loan, the lien allows the lender to seize the collateral to recover the owed amount.
Loan Agreement
This document outlines the terms and conditions of the loan, including the interest rate, the repayment schedule, and any penalties for defaulting on the loan. This can vary from a mortgage loan, a personal loan, a student loan, and a business loan.
Loan Amount
A loan amount is the total amount of money that a business borrows from a lender.
Loan Commitment
A loan commitment outlines the same terms and conditions as a loan agreement but is a more formal document that is typically used to secure financing.
Loan Covenant
A loan covenant is a condition or stipulation in a commercial loan or bond issue that requires the borrower to fulfill certain conditions or prohibits the borrower from undertaking certain actions, or possibly restricts certain activities to circumstances when other conditions are met.
Loan Documents
Loan documents are the paperwork that is used to secure a loan from a lender. This paperwork typically includes the loan agreement, the commitment letter, and any other relevant documents.
Loan Principal
The loan principal is the amount of money that is borrowed by a business. This number helps calculate the payments that a business must make on its loans monthly.
Loan Servicing
Loan servicing encompasses the administrative aspects of a loan from the time the proceeds are dispersed until the loan is paid off. This includes sending monthly payment statements, collecting monthly payments, maintaining records of payments and balances, collecting and paying taxes and insurance, and managing escrow and impound accounts.
Loan to Value
Loan to value (LTV) is the ratio of a loan amount to the value of the assets that are being used as collateral for the loan. This number is used by lenders to determine the risk involved in lending money to a business.
M
Merchant Cash Advance
A merchant cash advance (MCA) is a type of loan that provides businesses with quick and easy access to funds they need to pay their suppliers. A merchant cash advance provides businesses with an alternative financing option.
Monthly Payments
Monthly payments are the fees that a business pays to a lender to borrow money.
N
Net Income
Net income is the amount of money that a business earns after all expenses have been paid. This number is used to determine the profitability of a business.
Non-Recourse Loans
A non-recourse loan is a type of loan that is not secured by any collateral. This means that if the borrower defaults on the loan, the lender cannot seize any of the borrower’s assets.
Net Worth
Net worth is the total value of a person’s or business’ assets minus the total value of its liabilities. This number is used to determine the financial health and ability to repay outstanding loans.
O
Origination Fee
An origination fee is a fee that is charged by a lender when a business takes out a loan. This fee is typically a percentage of the loan amount and is paid upfront.
P
Personal Guarantee
A personal guarantee is a document that is signed by the owner of a business to guarantee that they will repay their loan. This document is typically used to secure financing from a lender.
Personal Loan
A personal loan is a type of loan that is taken out by an individual for personal, non-business use.
Pre-Payment Penalty
A pre-payment penalty is a fee that is charged by a lender when a business pays off its loan early.
Pre-qualification
Pre-qualification is a preliminary step in the loan application process, where lenders assess a borrower’s creditworthiness and ability to pay back a loan. This usually involves a soft credit check, which doesn’t affect the borrower’s credit score.
Prime Rate
The prime rate is the interest rate that is offered to the most credit-worthy borrowers. This rate is typically used as a benchmark to set the interest rates for other types of loans.
Principal and Interest
The principal is the amount of money that is borrowed by a business. The interest is the fee that a business pays to a lender to borrow money.
Principal Balance
The principal balance is the amount of money that is still owed on a business loan. This number is used to calculate the monthly payments that a business must make on its outstanding loans.
Promissory Note
A promissory note is a document that is used to secure a loan from a lender. This document usually includes the loan agreement, the commitment letter, as well as any other relevant documents.
R
Recourse Loans
A recourse loan is a type of loan that is secured by collateral. This means that if the borrower defaults on their loan, the lender can seize any of the borrower’s assets.
Refinance Transaction
A refinance transaction is the process of obtaining a new loan to pay off an existing loan. This process can be used to secure a lower interest rate or to consolidate multiple loans into one.
Repayment Period
A repayment period is the amount of time that a business has to repay its loan. This period is typically calculated as several months or years and must be paid back in regular installments.
Repayment Terms
Repayment terms are the specific details of how a business must repay its loan. This includes the amount of time that the loan must be repaid and the amount of each monthly payment.
Revolving Credit
Revolving credit is a type of loan that allows businesses to borrow money up to a certain limit and repay it over time. This type of loan can be used for a variety of purposes, such as working capital or inventory.
S
Secured Loan
A secured loan is a type of loan that is secured by collateral. So if the borrower defaults on their loan, the lender can seize assets from the borrower.
Short-Term Business loans
Short-term business loans are a type of loan that is used to finance a business’ short-term needs. This type of loan is typically repaid over months or years.
Small Business Loan
A small business loan is intended for business purposes only and the interest rate is typically lower than for personal loans.
Soft Credit Check
This is a type of credit check that does not affect credit score. It’s used to assess an individual’s or business’ creditworthiness without impacting credit score.
Subprime Loan
A subprime loan is offered to individuals or businesses who do not qualify for prime rates due to various risk factors, such as poor credit history or low income. These loans typically come with higher interest rates than prime loans to compensate for the higher risk of default.
T
Term Length
Term length is the number of months or years of a loan. This determines the number of monthly payments and the total amount of interest paid over the life of the loan.
Title Insurance Company
A title insurance company is a business that provides insurance to lenders in case there is a problem with the title of a property. This can help protect the lender’s investment in case there are any legal issues with the property.
U
Underwriting
Underwriting is the process a lender uses to assess the creditworthiness and risk of a potential borrower. This process involves evaluating the borrower’s credit history, income, assets, and other factors to determine the likelihood of the loan being repaid.
Unsecured Loan
Unsecured loans are a type of loan in which the borrower does not provide any collateral to the lender. An unsecured loan typically has a higher interest rate than a secured one, since there’s a greater risk for the lender.
V
Variable Interest Rate
A variable interest rate can change over the life of a loan. This type of rate is typically tied to an index, such as the U.S. Prime Rate, and will go up or down depending on the fluctuations of that index.
W
Working Capital Loan
A working capital loan is a loan used to finance the everyday operations of a business, such as inventory purchases, payroll, rent, and other short-term expenses. Unlike long-term loans, these are generally used to cover operational costs rather than for investment or expansion.
What are Four Business Loan Types?
Small business owners have many options when it comes to small business lending. Here are four main types of business loans:
- Term loans. These small business loan programs are typically for larger sums of money and have a repayment period of one to five years with an interest rate that’s usually fixed.
- SBA loans. These government-backed loans are available through the Small Business Administration (SBA) and have repayment terms of seven to 25 years.
- Invoice factoring. This type of small business loan uses your outstanding invoices as collateral. The lender gives you a portion of the invoice value upfront and the rest when your customer pays the invoice.
- Microloans. These loans are for smaller amounts of money, usually less than $50,000. They typically have shorter repayment terms than other types of loans.
Avoiding Common Pitfalls in Business Loan Borrowing
While business loans can provide valuable financial resources, it’s important to tread carefully to avoid potential pitfalls. Here are some common mistakes to steer clear of when considering a business loan:
- Overlooking Loan Terms: Failing to fully understand the terms and conditions of the loan agreement can lead to unexpected costs and obligations.
- Borrowing More Than Necessary: Taking on excessive debt can strain your business’s financial health and make repayment challenging.
- Neglecting Credit Score: Your credit score influences loan terms and interest rates. Neglecting it may result in unfavorable borrowing terms.
- Ignoring Hidden Fees: Be vigilant about additional fees that could impact your overall loan cost, such as origination fees or prepayment penalties.
- Misjudging Repayment Ability: Overestimating your business’s ability to repay the loan can lead to financial stress and potential default.
- Failing to Compare Offers: Not exploring multiple lenders can cause you to miss out on more favorable loan options.
- Not Having a Clear Purpose: Borrowing without a well-defined purpose or plan for utilizing the funds can result in inefficient spending.
- Not Reading the Fine Print: Carefully review all loan documents to avoid any surprises or discrepancies.
- Ignoring Market Trends: Failing to consider economic conditions and market trends could impact your ability to repay the loan.
- Rushing the Process: Making hasty decisions without thorough research can lead to regrettable loan choices.
| Pitfall | Description |
|---|---|
| Overlooking Loan Terms | Failing to understand loan agreement terms can lead to unexpected costs and obligations. |
| Borrowing More Than Necessary | Excessive debt can strain financial health and make repayment challenging. |
| Neglecting Credit Score | Your credit score influences loan terms. Neglecting it may lead to unfavorable borrowing terms. |
| Ignoring Hidden Fees | Be vigilant about additional fees impacting loan cost, such as origination fees or prepayment penalties. |
| Misjudging Repayment Ability | Overestimating ability to repay can cause financial stress and potential default. |
| Failing to Compare Offers | Exploring multiple lenders helps identify more favorable loan options. |
| Not Having a Clear Purpose | Borrowing without a defined purpose or plan can result in inefficient spending. |
| Not Reading the Fine Print | Thoroughly reviewing loan documents avoids surprises or discrepancies. |
| Ignoring Market Trends | Economic conditions and market trends should be considered to ensure loan repayment ability. |
| Rushing the Process | Hasty decisions without research can lead to regrettable loan choices. |
By being aware of these potential pitfalls and taking a cautious approach, you can make smarter decisions when seeking a business loan and avoid unnecessary financial setbacks.
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