how do business loans work

How do business loans work?

Small business loans can help you get the money you need to help your business grow. Learn more about these loans and how they may help your business. 

What is a business loan?

Simply speaking, a business loan is a type of loan that is specifically designed to be used for small business owners. They are similar to loans that can benefit your own personal finances and have a similar application process. These loans are to be used for business finances and can vary in loan amount, as well as the length of the loan term.

Small business loans work similarly to personal loans, with a formal application that may result in a loan offer. Upon receiving an offer, the terms of the SBA loan will be available, including the loan’s interest rate, monthly payments, and more. Keep in mind that you will have to pay interest on top of the principal amount borrowed over the lifetime of the loan. 

A typical small business loan amount will range somewhere between $1,000 to $50,000. However, this amount may vary greatly based on the cash flow within your business, its size, your personal credit score, as well as the business’s credit score. 

In addition, some business term loans may require the use of collateral to secure the loan. If you miss a payment or default on the loan, these assets may be seized as outlined by the loan agreement. 

how do business loans work

Different types of business loans

The two most common types of business loans fall into two main categories: secured and unsecured loans. After defining secured and unsecured loans, we will discuss a few different types of business loans. 

Secured loans

Secured loans require the use of an asset to secure the loan. This asset is known as collateral, which is typically some sort of property, stock, or another valuable item. If you fall behind on payments, the asset will be seized by the lender as a form of repayment for the loan. 

Secured loans offer the lender additional protection and these loans will often have lower interest rates than unsecured loans.

Unsecured loans

Unsecured loans do not require the use of collateral. Because of this, they will often have higher interest rates, as they have additional risk to the lender. The advantage of these loans is that you do not risk losing an important business asset if you cannot pay the loan back. 

Government-backed business loan

Some businesses, like start-ups, may find it hard to obtain a loan from a traditional lender. Instead, you may want to look at applying for a Start-Up Loan from the government.

Other government-backed loans may be hard to qualify for, but not impossible. The Small Business Administration does offer loans, but they can be extremely hard to qualify for. However, SBA loans often have lower down payments, interest rates, and lower monthly payments than many other options. 

Business line of credit

A business line of credit is somewhat similar to a credit card in that it has a limit that you borrow up to. In addition, like a credit card, you are able to use the funds and repay them as often as you need as long as you do not reach your credit limit. 

Business credit cards

A small business credit card works as your personal credit card, with additional features to help you track your spending.

Other types of small business loans to finance your business

There are a few other types of small business loans that can be used to finance your company’s expenses. Equipment loans, as the name suggests, allow you to replace or purchase new equipment as your business continues to grow. 

Small business term loans allow you to receive a lump sum of money with a fixed interest rate. These loans also feature set repayment terms, so you will know how much you owe each month. A typical business term loan is repaid within five years and must be used to fund a defined expenditure for your company. 

If you are looking to finance your business in another way, a merchant cash advance may be the solution you are looking for. However, these cash advances may end up being costly in the long term, so consider all other options, as a merchant cash advance can cause cash flow problems later.

Another option that does require a loan is to use invoice financing. Invoice financing allows a business to borrow money against what their customers owe them. This helps to improve a company’s cash flow and reinvest money into operations and growth opportunities for the company.

What can business loans be used for?

When you apply for a business loan, chances are, your lender will want to know what the loan is going to be used for. These loans cannot be used for personal reasons. Here is a list of common uses for business loans:


If you are using a loan to increase cash flow within your business, it can be used for many different purposes. It will typically cover things like repairs, covering old debts, or helping a business during its slow seasons.

Property costs and Asset purchases

Property costs and asset purchases cost a lot of money that is not easily attainable from just day-to-day cash flowing within your organization. If you are looking to buy new equipment for your company or are making a deposit on a storefront, these loans can help your business. 

Long-term finance

Business loans can also be used for long-term investment costs. These longer-term loans usually take time to start bringing in increased revenue for your business. Loans in this category are typically used to finance things like research and development, launching new lines or new business divisions, or for large expansion projects within a company. 

How to increase the chance of qualifying for a business loan

The best tip to increase your chance of qualifying for a business loan is to build a strong credit history in both your personal and business credit accounts. Be sure to pay bills on time, keep your credit utilization rate low and pay off any debts you may have. After your personal credit is squared away, it is now time to work on improving and building the credit health of your small business.

Another great way to increase your chances of obtaining a loan is to have an understanding of different lenders’ requirements, such as minimum credit score and annual revenue. In addition, work to develop a strong business plan. This plan will outline and show the lenders how you plan to use the money you are borrowing and the purpose of the loan. 

The final way to increase your chances of qualifying is to be prepared to provide collateral for a secured small business loan and to explore all options before deciding the type of loan your business needs. Be sure to always prioritize paying back the loan on time.

The bottom line

Before applying for a business loan, there are a few things to consider:

  • How much you want to borrow: Keep things like interest payments and how much money you actually need before applying for a loan. Do the math ahead of time to see exactly how much money you need to complete a project. 
  • How much you can afford to pay back each month: This may change how much you want to borrow or how long you want to borrow the money for. Remember, shorter loan terms equals less interest costs, but higher monthly payments. Include any extra fees and interest payments when considering how high of a monthly payment you can afford. 

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