Questions Before a Bad Credit Business Loan
A business loan can be a powerful tool to help you grow to the next level, or it can hurt you unexpectedly. Whether it’s your first time applying for a business loan or your third, there are some basic questions you should always ask before taking out a bad credit business loan. Answering these questions before you apply will send you down the path to a successful borrowing experience.
How bad is my credit?
Because lenders charge interest and fees as a way to mitigate risk, you’ll pay more for access to money if you have a poor credit score. If a few simple steps; such as paying down balances on credit cards or a few more months of on-time car payments, could improve your credit score, ask yourself if you can wait to apply for that business loan.
Also, if your score is below 500, it’s extremely hard to get even a bad credit business loan. Unless you’ve been in business for a long time and your business has strong financials, you’ll need to bring up your personal credit score before applying.
What’s my purpose in getting the business loan?
It sounds like a simple question, but many business owners may know they need money without having a clear purpose in mind. “I want to remodel my store,” is a general statement, versus, “I want to refinish the hardwood floors, paint the walls, and re-carpet the dressing rooms in my store.” The more specific you are, the better you’ll be able to choose the right loan to meet your needs.
Determining your purpose guides you in whether or not to take out a short-term or long-term loan. If you only need a loan to purchase extra inventory for the holiday season, you don’t want to be paying on it ten years later. Alternatively, if buying a fixed long-term asset that you intend to keep for ten plus years, extend your payment term to lower your payments.
Interest rates are usually higher for a short-term loan than for a long-term loan because the lender has a shorter period over which to make their money. Even if a lower interest rate looks better to you, the general rule is that the length of time you’re paying for the asset should match the asset’s expected life. Once you’ve clarified your purpose, you can determine how much money you need.
How much money do I really need?
Before even talking to a broker or lender, crunch some numbers. Lenders specialize in industries, loan size, and type of borrower. Without a clear number in mind when talking to an alternative lender, you could waste valuable time completing applications and gathering financial data for someone who would never lend to you in the first place.
As well as helping guide you to the right lender, the process of drilling down on a number clarifies your business goals. Considering unexpected expenses that might arise during a planned store remodel, for example, and building them into your loan amount ensures that the project stays on track. You don’t want to get low on funds halfway through a long-term plan and have to take out another loan.
It also keeps you from borrowing too much. While some people might advise you to take out more than you need, just in case, this will cost you. You’ll pay more in fees and interest, both of which are usually calculated off the balance loaned. You want to make sure that your number crunching shows that the project or initiative for the loan will make more money than the cost of the loan; otherwise it is a waste of time.
Both fees, interests, and other loan costs are built into an annualized percent rate, or APR. It’s a better representation than a flat interest rate of what you’re actually paying because it includes other components of the loan’s cost. Not all lenders provide this rate unless asked, but in the long run a loan could cost far more than you anticipated if you didn’t take its APR into consideration.
Lastly, if you’re struggling to make payments on debt that you didn’t need it could impair your ability to use the loan’s funds for their intended purpose. This is why it is a good idea to stick to what your business really needs, which in turn results in a reasonable payment.
Can I service this debt?
Be honest with yourself. Often, it’s difficult for failing business owners to acknowledge that their dream hasn’t worked out. Borrowing in a panic, trying to stay afloat, might seem like a good idea while you try to work things out but it rarely ends well.
Is this a normal, seasonal cycle from which you know you’ll recover? Or have revenues been steadily declining for years? Take a good look at your cash flow, both historical and projected, and make sure that you’ll be able to make the loan’s payments. After all, you don’t want this loan to make your poor credit score worse!
You may think that a lender wouldn’t approve you for a loan unless they know you can pay it off. Unfortunately, there are unscrupulous lenders out there who might give you a loan knowing that they can seize any assets you’ve pledged as collateral and cover their losses.
How will this loan impact my credit score and future ability to get funding?
A loan can impact your credit score even if you’re paying on time. Debt makes up 30 percent of a credit score, so raising your debt level changes the score’s final calculation. Try using a credit score simulator to get a rough idea.
A bad credit business loan will also impact your debt to income ratio. Calculate this ratio by dividing your gross income by monthly expenses. Then calculate it again with the new loan payment added to those costs. Lenders sometimes consider this and other ratios when making lending decisions.
If the new loan might drive your credit score even lower and you’re concerned that you could need more credit before it’s paid off, then it may be a good time to consider borrowing more. There’s a lot to think about when applying for a bad credit business loan. Taking the time to answer these questions thoroughly may prevent you from making another mistake that damages your credit score or your business.
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