Finding the best type of finance to grow your business in one of the biggest challenges for business owners. We take a deep dive into business loans, what interest rates mean and where they come from, and what security is and why lenders take security.
Before we get into the details of what business loans are, let’s start with the basics.
What exactly is a loan and how can it help businesses? In the broadest sense of the term, a loan is an amount of money that is borrowed by a recipient and expected to be paid back at an agreed date. Loans can be used both personally, for groceries, school, weddings, or for businesses, e.g. to start to grow a business.
Loans are generally provided by lenders, and for businesses, these include banks, financial institutions, or even governments. There are several different types of loans, and it’s largely based on interest rate repayments, the terms of repayment, and security.
What are Interest Rates?
Interest rates are easily confused with the many fees and charges that could apply to loans. There are many providers of business loans, including banks and alternative funders, so there are also lots of different interest rates. Interest rates can vary depending on the lender, but also the rates that are given can depend on the circumstances and requirements of the business.
For many common products such as secured business loans, commercial mortgages and receivables finance (e.g. invoice discounting and invoice financing), the larger high street banks are often the most price competitive and have economies of scale, as well as access to capital as the best market rates. The other reason why they can offer the best price is that they look at the lowest risk businesses and will often turn down any new start or small / riskier trading businesses.
At TFG however, it’s often easier for us to access more appropriate (and therefore often cheaper) types of finance for your business, as we’ll be able to work with a whole range of finance providers who can lend to businesses for specific situations or have certain criteria, and it’s getting that fit right that can reduce the cost and interest rate.
These alternative financiers also specialise in lending to businesses where not much information or trading history is available, and their speciality is helping those who the banks cannot help.
It’s also important to note that often security, through the form of business assets, personal or directors guarantee might be required, although, for smaller niche lenders, they might ask for less security than high street banks, especially for loans under £250k.
What about credit score?
Credit scores do not get checked or looked at when signing up on TFG, talking to any of our business or commercial finance specialists, or discussing the different types of funding or commercial finance available for your business. However, many of the lenders that do look at whether or not they can lend to your business will require a credit check as part of the business finance application process, but they would always ask for your permission to search for this.
You’d never get credit checked or have your business credit checked unless you give explicit consent, and as for personal data or personal credit checks which are highly regulated, your rights are for your personal data to always be protected.
Do I need a personal guarantee?
For business loans, sometimes a lender might ask that you are personally responsible for a business loan should the business default on repayments.
A personal or directors guarantees ensure that you will give an additional security which means that the lender can pursue you personally should payments by the business not be met.
Personal guarantees mean you agree to act as a guarantor for the business and could increase your chances of getting finance for your business, often a positive move towards the growth of the company. However, to directors of the business, the risk of giving a personal guarantee is considerably higher, and it’s a personal financial commitment.
That said, personal guarantees are not unusual, commonly used if looking for an unsecured business loan or revolving credit.
Is my home the security?
People often think of personal guarantees as using a property (their home) as security. Whilst both are often used to secure business finance, they’re not the same.
Financiers will often ask if you’re a homeowner or own property so that they know you’ve been through the complexities of due diligence in the past, not necessarily because they want a charge over your home.
That being said, you should not let interest deter you from applying for a loan. Most lenders will work with you to figure out a repayment schedule that works for you. What is a repayment schedule? A repayment schedule is the calendar of time for which you must pay back your loan. This includes the total length of time that you have to pay back the loan, the frequency of payments, AND the amount of money that you will pay on each date.
Repayment schedules vary from loan to loan, too. The most common repayment schedule is monthly, meaning that the borrower makes a payment every month for the allocated number of years. There are also annual loans, where you make one lump payment every year. Finally, there are quarterly or semi-annual loans, which are made a few times a year.
Once you start getting into repayments, you will hear about something called a “grace” period. What this means is that you get a certain amount of time (again, this will be pre-determined by your lender when you are approved for your loan). The grace period usually ranges from about three months to a year, but every loan is different. The important thing to remember is when YOUR grace period ends because this is the time that you must make your first repayment. Also, for some loans, during the grace period you do not have to pay interest, but sometimes in grace time, you pay only interest.
Remember, one of the biggest factors in being a borrower is being responsible, and that includes remembering when you have a payment due.