You have decided to start your own business. The idea is in place. The market needs a gap identified. Research and market analysis done. And now the only thing left is – where will the money come from?
Well, you have one of two options – either opt for traditional business loans or Small Business Administration (SBA) loans. Both types of loans have their pros and cons. But when it comes to funding your dream venture there are a few more factors you must take into consideration.
In this article, we deep-dive into the world of SBA loans and Traditional loans. Read on for more.
What are SBA loans?
Small Business Administration Loans or SBA loans are financial lending instruments backed by the U.S. Small Business Administration (SBA). While the SBA doesn’t not lend directly to businesses, it does, however, guarantee a portion of the loans issued by partner banks, credit unions, and other lenders.
Thereby reducing the lender’s risk and allowing them to offer more favorable terms to consumers. This in turn makes SBA Loans a good option for budding as well as seasoned entrepreneurs.
While there are many categories of SBA loans, SBA 7(A) Loans are the most popular. Owing to their versatility, covering working capital nature, equipment purchases, real estate purchases, and even refinancing existing debt, SBA 7(A) Loans are becoming widely popular among small business owners.
Key points to consider when opting for SBA loans:
- Approval time – The approval time for SBA loans is between moderate to lengthy, so it could take anywhere from weeks to months.
- Eligibility- SBA loans are designed especially keeping small businesses in mind. So, the requirements for credit scores, revenue, and business size are flexible.
- Collateral- Often required, but not always.
- Interest rates- Competitive, often lower than traditional loans.
- Payment terms- Long repayment periods, up to 25 years for real estate and 10 years for equipment or working capital.
What are traditional business loans?
Another option available to small business owners are Traditional Business Loans. Offered directly by banks and credit unions without a government guarantee, these loans often have stricter eligibility requirements but also provide quicker access to fund if you qualify. Traditional Business Loans are ideal for businesses with established credit histories and robust financials.
Key points to consider when opting for Traditional loans:
- Approval time – It is usually fast and could take anywhere from a few days to a couple of weeks.
- Eligibility – It is usually strict. Businesses always need a strong credit score, financial stability, and proof of profit.
- Collateral – Almost always required.
- Interest rates – Vary widely; typically, higher than SBA loans, especially for borrowers with average credit.
- Payment terms – Shorter repayment periods, usually up to five years.
Difference between SBA loans and traditional business loans
Time for approval
SBA Loans: Approval for an SBA loans can be time-consuming. The application process involves multiple steps, including preparing extensive documentation and waiting for the SBA to review your application. The entire process can take anywhere from several weeks to a few months.
Traditional Loans: In contrast, traditional loans are faster. Banks review your application and provide a decision within a few days to a couple of weeks, making them ideal for businesses in need of immediate funding.
If your business can afford to wait, SBA loans may offer better terms. But if speed is a priority, traditional loans might be your best bet.
Eligibility requirements
SBA loans cater to small businesses, making them accessible to startups or those with moderate credit histories.
Requirements include:
– Being a for-profit business.
– Operating in the U.S. or its territories.
– Meeting the SBA’s definition of a small business, based on revenue or employee count.
Traditional loans, on the other hand, are ideal for businesses with strong credit scores (often 700 or higher), a recorded history of profitability, and established operations since lenders will scrutinize your credit report, annual revenue, and debt-to-income ratio.
If your business is still growing or lacks a good credit score, SBA loans are the way to go. But on the flip side, if your financials are solid, a traditional loan could offer quicker access to funds.
Collateral requirements
Collateral is an important parameter to take into consideration when looking at SBA loans and traditional loans.
SBA Loans: While not always non-negotiable, collateral is often asked for borrowing larger loans. If your small business does not have collateral, the SBA may still approve your application by looking at other factors. These factors could be your cash flow and credit history.
Traditional Loans: Collateral is almost always mandatory for traditional loans. It could be real estate, equipment, or other assets, but lenders want reassurance that their investment will be protected in case of non-repayment.
Interest rates and payment terms
Interest rate and repayment periods will, with absolute certainty, influence your decision.
SBA Loans: Thanks to the SBA’s backing, these loans generally offer lower interest rates. For example, SBA 7(a) loans now have variable rates tied to the prime rate, ranging from 10% to 12%.
Their repayment terms are also quite generous—up to 10 years for working capital and 25 years for real estate. These extended terms can lower monthly payments, which in turn makes it easier to manage your cash flow.
Traditional Loans: Interest rate vary depending on your creditworthiness. It typically ranges from 5% to 30%. Repayment terms are also shorter, usually ranging between 1 to 5 years. This results in higher monthly payments.
If your business needs smaller payments spread over a longer period, SBA loans are a clear winner.
Loan amounts
Both SBA and traditional loans offer substantial funding, but the maximum amounts differ for each.
SBA Loans: The SBA 7(a) program provides loans up to $5 million.
Traditional Loans: The loan amount depends entirely on the lender and your creditworthiness. Some banks even offer loans exceeding $5 million for well-qualified borrowers!
If your funding needs are significant and you qualify, traditional loans may be able to meet your requirements.
The right loan for you
Go for an SBA Loan if:
1. You have a limited credit history or are a small business.
2. If lower interest rates and longer repayment terms reduce monthly payments work for you.
3. You have the time and do not mind a longer wait for approval.
4. Your business objective aligns with SBA programs, such as the SBA 7(a) Loan for working capital or real estate.
Go for a traditional business loan if:
1. You require quick funding to seize an opportunity or for an emergency.
2. Your business has proven creditworthiness i.e. a strong credit score and shows consistent profitability.
3. You can effectively and efficiently manage higher interest rates and shorter repayment terms.
4. You have sufficient collateral, whether tangible or intangible assets, to back the loan.While both have their pros and cons, choosing between an SBA loans and a traditional business loan comes down to your business objectives and current financials.
