Christopher Watson has more than 30 years experience in commercial lending and is senior vice president and senior lending officer of the business banking division at Webster Five in Auburn.
Updated: February 21, 2022
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What to know before taking out a business loan
By Christopher Watson
A business loan can get you the money you need to jump start a new venture, expand current operations, or purchase equipment. Lenders have many different options from U.S. Small Business Administration loans to lines of credit. There are varying costs and terms associated with any type of loan, so make sure you know the specifics.
1. Is my interest rate locked in?
Business loans may have fixed or variable interest rates. A fixed-rate loan locks in the payments for the life of the loan. You know the total cost of the loan from day one. A variable-rate loan may have a lower interest rate to start, but that rate is tied to a market index that can fluctuate, causing payments to change.
2. How much are the closing costs?
All loans have associated fees. These may include an underwriting fee for reviewing and verifying loan application information and closing costs associated with servicing the loan. Fees vary based on the loan size, loan type, repayment term, and the financial health of the business. They can add up, so ask whether you must pay them at the loan closing or if they can be rolled into the payment schedule.
3. What collateral do I need?
You may be able to use personal assets such as stocks or real estate as collateral if business assets aren’t sufficient. Accounts receivable and future revenue may be considered. The collateral requirement depends on the loan-to-value ratio set by the lender. For example, an 80% LTV means you can borrow $80,000 if you pledge collateral worth $100,000. There also are unsecured loans with no collateral requirements. Whether or not your business qualifies is based on personal and business credit scores as well as the business’s overall financial picture.
4. What financial covenants do I need to be aware of?
These are designed to mitigate lender risk or get both parties back to the table if the company isn’t performing as expected. Terms may require the business maintain sustained cash flow and/or profitability.
Look terms over carefully and include your accountant in the discussion. A breach can result in the lender gaining the right to charge a higher interest rate, collect collateral, or even call in the loan.
5. Are there penalties for late payment or paying off the loan early?
Pre-payment penalties are typically a percentage of the total loan and lenders do it because they will be losing interest income revenue. Any fees, including late-payment penalties, should be disclosed in your loan offer or final agreement.
A good lender will be completely transparent and happy to answer all your questions. The relationship may start with getting the loan, but ultimately your lender is a partner and resource.
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