Small Business Loans Tips
Bank Business Loans vs Alternative Loans
Building or expanding your business requires cash. Which means if you want to grow, you’re probably going to need a business loan. There are lots of options for business loans, but navigating through the process can be difficult. The first decision you need to make is between a traditional lender and an alternative one.
So let’s take a look at the difference between the two. Once you understand this distinction, you’ll have a better idea of which is right for you. We’ll start with the basics:
Where Do Alternative Business Loans Come From?
Traditional business loans come from banks. Alternative business loans come from . . . well, anywhere else. There are two major types of alternative business loans providers: crowd lenders and direct lenders.
Crowd lenders connect borrowers with investors. Usually you’re not connected with a single investor—investors buy some form of shares or notes from the lender and then the lender gives you the money.
Some alternative lenders provide personal loans that can be used for business. Others provide business-specific loans. (The difference, in many cases, is fairly small—we’ll talk about some of them shortly.)
Direct lenders have their own capital to lend to businesses. They’re a little bit more like banks. You borrow money directly from them and pay them back.
Is one better than the other?
Not really. If you like the idea of supporting individual investors, using a crowdlending service will let you do that. If you’d rather have the solidity of a single lending organization, a direct lender might be a better choice. In the end, though, it’s best to look at the specifics of each loan. Now let’s talk about one of the most important reasons you might choose an alternative business loan:
Application and Approval Process
The Denver Post shared a story about Bob, a successful businessman who needed a $250,000 loan. He had good credit and a business that had been growing for 10 years. Not only did he get denied his business loan, but it took the bank two months to respond to his application. Banks can be stingy when it comes to giving out loans. Even if you have a decent credit score and a respectable business history, you might not get approved.
And that’s one of the best reasons to apply for alternative business funding.
The application process is often easier than with traditional banks and many lenders can get you money fast. (Some alternative lenders respond to applications within 24 hours. And in some cases, they’ll send you money the same day you’re approved.) There’s no question here—alternative loans provide a better application and approval process. They’re easier, faster, and require a lot less paperwork. But are you more likely to get approved? That depends:
Getting a Business Loan With Bad Credit
Many people looking for alternative business loans are doing so because they have bad credit. (In case you’re wondering, there’s no definitive guide for what’s considered a “bad” score, but below 620 is a red flag for some lenders, and under 500 is definitely bad.) And it makes sense: traditional lenders are only going to approve you for a loan if you have a fantastic credit score.
Alternative lenders, on the other hand, provide bad credit business loans to borrowers with all sorts of credit ratings. Some alternative lenders specifically state that they consider loans to borrowers with bad credit scores. Some also do soft credit checks instead of hard ones, which is great when you don’t want your credit score going down a few more points.
If you have a really low credit score (below 500), you may still have difficulty finding someone to loan you money. And if you do, you’ll probably be looking at higher fees, higher interest rates, and less flexible loan options.That being said, if you need cash to expand or run your business, it might still be worth it if you don’t have another choice.
Remember that you can always defer taking a loan until you’ve had some time to improve your credit score. It might be worth it.
Types of Business Loans
Both banks and alternative lenders offer a variety of loan types. As mentioned earlier, both business and personal loans can be used for business purposes. Business loans usually have more requirements. Here are a few things lenders may consider:
- How long you’ve been in business
- Your average annual revenue
- Your personal credit history
- The industry your business is in
- Collateral that you can offer
There are benefits, too; you may be able to get a larger loan amount (Wells Fargo offers up to half a million for some small business loans) and you may be protected if the business defaults.
Personal loans are generally smaller (Wells Fargo goes up to $100,000). But they’re easier to get—they don’t require collateral, and you don’t need to provide as much information.
Traditional and alternative lenders also offer both short and longer term business loans. Most short term business loans range from two months or up to three years. Longer term more traditional loans can run much longer—think five to seven years. Most alternative lenders offer business loans between a couple months and three years. Banks are more likely to offer the loans with terms from one to five years if you have excellent credit and financials.
Interest Rates and Fees
Now we come to a common question: do traditional business loans or alternative loans come with higher interest rates? The answer is complicated. Lenders of all types offer a variety of loan types with different interest rates and fees, and your credit score may affect your annual percentage rate. Let’s look at a short term unsecured business loan.
Here are a few places you could get it:
|Wells Fargo||1–5 years||up to $100,000||7.75% and up||None|
|Bank of America||1–5 years||up to $100,000||6.25% and up||$150|
|OnDeck||1–3 years||up to $500,000||9.99% and up||2.4–4% of loan amount|
|Lending Club||1–5 years||up to $300,000||9.77% and up||1.99–8.99% of loan amount|
|Shield Funding||up to 3 years||up to $1,000,000||9% and up||1–2% of loan amount|
In this particular example, you’ll pay more interest if you go with an alternative lender. And the fees are significantly higher (2.4% of a $250,000 loan is $600).
Let’s see what a $150,000 loan (over three years) would cost you, in total from those providers, assuming you get the best interest rates and lowest fees:
- Wells Fargo: $168,594.28
- Bank of America: $165,040.84 (lowest)
- OnDeck: $174,577.46 (highest)
- Lending Club: $173,958.78
- Shield Funding: $171,868.56
If you chose Bank of America instead of OnDeck, you’d save about $9,500. That’s a big difference. Of course, it’s probably harder to get approved for the Bank of America loan. Especially if you have bad credit. And you’d almost certainly get the approval and the funds from OnDeck a lot faster. Is that worth almost $10,000? It might be. It depends on your situation. This is a very simple look at some numbers—it’s unlikely that you’d get the lowest fees and interest rates from every lender. But it serves as a good lesson: Making the right choice can save you a lot of money.
Choosing the Right Loan for Your Small Business
It pays off to choose the best lender, whether traditional or alternative. As you saw in the section above, it can be costly to make the wrong choice. So you’ll need to do some comparing. Upstart has a great loan calculator that can handle percentage-based origination fees, which is especially useful for alternative business loans.
Of course, you might not know your interest rate until you’ve applied for the loan. Which means you can’t compare loans that you haven’t yet been approved for. That complicates things even further. Your best bet is to keep a spreadsheet where you can track your applications and total costs of each loan. It might seem like a lot of work. But it will pay off in the long run.