Bank Loan Basics

Bank Loan Basics

It’s not easy to borrow these days—but it’s still possible.

Not long ago, the first place many entrepreneurs turned for funding was their bank. That’s changed since the credit crisis hit the United States. With many banks struggling for survival, it can be tough for even seasoned business owners with a strong credit history to get a loan. “It has absolutely gotten harder,” says James Stadtmueller, vice president of Peapack-Gladstone Bank, a commercial lender with 24 branches in Central New Jersey that work with many small businesses.

That doesn’t mean bank loans are not worth pursuing. Just be prepared to do a lot of legwork to find a bank that is willing to lend and to provide plenty of documentation proving that you will pay back the loan.

What types of financing are available from a bank?

The two main types of small-business financing available are traditional loans and credit lines. In a bank loan, you borrow a fixed amount, such as $10,000, that is due by a certain date, explains Donna Marie Thompson, a former consultant with PriceWaterhouseCoopers who now advises small businesses as CEO of Goals in Action in Washington, D.C. You must make a set payment each month that covers the money you owe, plus interest. Typically, bank loans run for seven years, but the term may vary, Thompson. With a credit line, you are eligible to borrow whatever amount you need up to a certain limit, during a set period of time, such as a year. “You can take the full amount out until the end of the term,” says Thompson. “You can also, for instance, pay it down by $3,000 and then borrow more.” You pay a fee to open the credit line but only pay interest on the money you actually borrow.

Is a bank loan a good fit for me?

Before you invest a lot of time in applying for a bank loan, it makes sense to consider your chances of succeeding. Bankers generally prefer to lend to small business owners with solid experience in their industry who have run their ventures profitably for at least a few years. Startups have a much harder time getting loans. “Bankers always prefer to look at history, rather than projections,” says Stadtmueller.

“Bankers always prefer to look at history, rather than projections,”

If you are starting a new business, having corporate experience in your field can help tilt the odds of getting a loan in your favor, but isn’t as strong a selling point as you might think. “There are a lot of people who left their job in the Fortune 500,” says Stadtmueller. “You’d be surprised at how many of those people become casualties. They are used to a world where there is a ton of support and resources. When they are on their own, they don’t have the wide range of knowledge they need to be successful.”

You also need to be willing to put a fair amount of your own money into the deal. Banks these days will typically expect to see you putting up at least 25% to 50% of the financing you need to get a loan that is not guaranteed by the Small Business Administration(SBA), says Stadtmueller. For an SBA-backed loan, the minimum amount is 15%. “The more skin you have in the game, the better,” he says. Banks will often want to see that you have outside sources of income or the involvement of a backer who has the financial resources to support the business by, for instance, guaranteeing its debt or helping to keep the shelves in a retail store stocked if sales are slower than expected, he adds.

 Banks these days will typically expect to see you putting up at least 25% to 50% of the  financing you need to get a loan that is not guaranteed by the SBA.

How much does it cost to get a bank loan?

Interest rates vary considerably on bank loans, but they are usually lower in the longer term than for other common types of funding, such as credit card financing. If you took out a bank loan for $25,000 or less that was backed by the Small Business Administration and was due in seven years or less, the maximum interest rate was 4.25% plus the prime rate (3.25% in July 2011), for a total of 7.5%.

How can I apply for a bank loan?

Before you approach a bank for a loan, build a working relationship with a banker by opening your personal and business accounts there, advise many business experts. A banker who is familiar with your venture will be able to help you find the loan that is the best fit for your business. Typically, at Peapack-Gladstone Bank, bankers will look at loans that are not guaranteed by the SBA first, says Stadtmueller. These are easier to process. “The SBA unfortunately has a reputation for being very paper-intensive,” says Stadtmueller. But for startups and other companies seen as riskier bets, the company will look to loans guaranteed by the SBA, to make sure it has protection if you can’t pay your debt back.

Each bank has its own application process for loans that are not backed by the SBA. Some will require you and any other owners of the business to provide personal financial statements, notes Thompson. At Peapack-Gladstone Bank, there is no written application. “We interview someone over the phone or face to face,” says Stadtmueller. “We write a memo that serves as the application.”

If you apply for an SBA loan, both you and the bank will need to fill out forms the government requires, says Stadtmueller. If a bank has reviewed your business plan and financial records for your business and approved the loan, it will submit its approval and the forms you have filled out to the SBA.

You will usually be asked to provide the banker with a business plan—often the deciding factor on whether you get a loan—so have one ready before you apply. “Nine out of 10 people don’t get it right,” says Stadtmueller. If you can’t afford to hire a professional consultant who specializes in writing business plans, seek free or low-cost help from SCORE, a nonprofit that advises small-business owners, he says.

What should your plan include? “I look for an outline of what your company’s competitive advantage is, who your competitors are, a discussion of price points, financials for the first two to three years, done on a month-by-month basis with copious notes, references, and assumptions,” Stadtmueller says. “I would like to see month-by-month and sometimes week-by-week projections of revenue and expenses, with all the expenses listed. Most of the business plans I see that are not professionally prepared are by people talking about how great their little dress shop is going to be, but with no comparison with the other dress shops in town.”

“I look for an outline of what your company’s competitive advantage is, who your competitors are, a discussion of price points, financials for the first two to three years, done on a month-by-month basis with copious notes, references, and assumptions,”

What happens if I don’t pay back the loan?

You will usually need to provide collateral for a loan. This is property or investments that the bank can seize and sell if you do not pay back the money you owe. It may be business equipment or vehicles, but if your business doesn’t have any valuable property, you may be asked to use your home as collateral. That can be risky if your business fails, as you will not only be out of work but forced to leave your house. “People need to be very careful about what they put up as security,” says Thompson.

How is borrowing from a credit union different than borrowing from a bank?

Credit unions are nonprofit financial institutions formed by a group of people with a common profession or other affinity, according to the Credit Union National Association. The members pool their money to provide services to one another, such as loans.“Credit unions are usually friendlier than banks,” says Thompson. “You’re a member. They’ve got some understanding of who you are.” Rates are typically competitive with banks.

Credit unions don’t want to lose their members’ money, of course. “You may not need a business plan, but you need to provide detailed monthly cash-flow statements,” Thompson says. You will probably also have to put up collateral.

Are there special considerations for immigrants in getting loans?

Banks are leery of lending to anyone who doesn’t have a strong credit history, so if you haven’t had a chance to build your credit score in this country, borrowing may be challenging, notes Alan Tratner, director of Green2Gold, a nonprofit organization that runs a national network of low-cost work spaces, known as incubators, for environmentally-friendly businesses, and a Santa Barbara-based counselor with SCORE. If you don’t have a strong credit history, you may need to get a co-signer for your loan. This is someone who agrees to pay it back if you can’t. “There is a lot of co-signing going on right now,” says Tratner.

To qualify for a loan backed by the Small Business Administration, you need to be a citizen or a legal alien. “If you are temporarily here, that’s going to be a major problem,” says Tratner.

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