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Small Business

How Does a Business Loan Work?

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It may not have been previewed, commissioned or otherwise endorsed by any of our network partners.

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In the course of day-to-day operations, many businesses discover they come up short on the necessary cash to pay expenses, employees and other business costs. To cover this gap, many business owners turn to business loans.

So, how does a business loan work? Business loans can provide much-needed capital to ease cash flow and help businesses stay on top of their bills. Especially helpful during slow seasons, business loans are a tool that business owners can use to keep business operations moving smoothly.

How do business loans work?

Business loans provide business owners with operating capital to pay expenses, payroll and other costs during slow times or when waiting for client payments to come in.

Most business owners rely on one of six types of small business loans to provide the cash they need. Deciding which financing option to choose depends on the individual needs and financial situation of the business. Some business owners need a small infusion of cash they plan to repay quickly, while others need a large amount of capital as well as time to repay that money.

6 types of small business loans

1. SBA loans

SBA loans are guaranteed by the Small Business Administration (SBA). These loans are not offered directly by the SBA but rather through SBA partners, such as banks, that agree to adhere to SBA guidelines for the loans. In general, the money can be used to pay expenses, cover rent or mortgage payments and buy equipment, among other costs. However, some loan programs do set restrictions on what the funds can be used for, so talk with an SBA-approved lender for specific requirements to determine if the loan fits your needs.

Because the SBA backs a portion of the loan, the risk for lenders is reduced, paving the way for them to offer larger loan amounts — ranging from $500 to $5 million — and more favorable terms. In general, SBA loans have lower down payments, do not require collateral and offer low interest rates, typically ranging from 5% to 10% depending on individual factors and financial needs.

Repayment terms are usually dependent on what the loan is used for, with maximum maturities set for SBA loans. For instance, the maximum maturity of a loan used for real estate is 25 years, while the maximum maturity of a loan used for equipment, working capital or inventory is 10 years. Like other loans, payments are usually made monthly.

To be eligible for an SBA loan, a business must:

  • Be located and operate in the United States or its territories
  • Be a for-profit business
  • Meet size standards based on the SBA’s definition of a small business
  • Have an owner who has invested equity into the business
  • Have exhausted all other financing options

2. Term loans

With a term loan, the business borrows a specific amount of money, which it must then repay over a set period of time with interest. These loans can be set up to be paid over the long or short term. The features of each loan, as well as your business needs and financial circumstances, will help determine which loan is right for your business.

Often used to cover equipment purchases or construction costs, long-term loans are paid over anywhere from three to 10 years, and sometimes longer. The interest rates of long-term loans tend to be lower compared to those of short-term loans. However, long-term loans can be harder to obtain, generally requiring collateral to secure the loan, a good business credit history and at least two years in business.

Short-term loans, on the other hand, are typically used to fill the cash flow gap for payroll, purchase office supplies or pay utility bills. They generally require repayment within three to 18 months and typically have higher interest rates. Unlike long-term loans, which may take quite a while to apply for and receive approval for, short-term loans have a much simpler application process that results in quicker funding, even for businesses that may not have a solid credit history.

3. Equipment financing

Equipment financing refers to business loans used to purchase equipment for the business, such as vehicles, commercial kitchens and construction machinery. The equipment itself serves as collateral for the loan, meaning the lender can repossess the equipment if the business defaults.

Business owners repay this loan over an agreed-upon period of time with a relatively low interest rate. Qualifying for equipment financing tends to be much easier compared to other types of business loans because the business does not have to be established for a specific period of time nor does the business owner need valuable assets or excellent credit.

4. Invoice financing

Invoice financing, also called accounts receivable financing, refers to a loan that works like a revolving line of credit. However, instead of basing the loan amount on assets or real property collateral, this financing arrangement is based on a company’s average invoice volume. The lender examines the company’s weekly volume of invoices and then may offer between 70% and 90% of the average invoice volume.

This type of financing often is used to provide needed cash flow that will cover payroll expenses, utility bills or the purchase of office supplies. Business owners are not obligated to take the entire loan amount at one time as with a traditional loan. Instead, they can draw out only the amount of funds needed at any given time, similar to a line of credit.

As with other business loans, invoice financing terms include interest rates and repayment terms. While fees and interest rates vary, companies often charge a processing fee of approximately 3% of the total invoice amount as well as a factor fee based on how long it took the client to pay the invoice. The factor fee usually is taken weekly and equates to approximately 1% of the total invoice amount.

Qualifying for invoice financing typically requires a good credit history as well as a proven record of invoices.

5. Business lines of credit

A business line of credit is a business loan that works like a credit card. Once approved for a predetermined credit limit, business owners can access the cash they need when they need it rather than taking out the entire amount at one time. They can use these funds to cover payroll, hire new employees, purchase goods or even grow and expand their business.

Once the borrowed amount is repaid, the business owner can access the full amount once again. When repaying the borrowed amount, business owners will pay interest only on the amount borrowed. Interest rates on lines of credit can be higher for those with a poor credit history.

Applying for a line of credit is similar to applying for a traditional loan. You’ll need to complete an application, provide financial documents and go through a personal credit check. In addition, you may need to sign a personal guarantee or provide collateral to receive approval.

6. Merchant cash advances

A merchant cash advance provides cash to business owners in exchange for a specific percentage of their future debit or credit card payments. Funds obtained through this financing option often are used to purchase new equipment, obtain seasonal merchandise to supplement regular inventory or even pay for building expansion or remodeling.

With a merchant cash advance, the lender — usually a non-bank lender — issues a set cash amount, and as you process debit or credit card payments, the lender takes a percentage of each payment and applies it to your loan balance. As such, payments are based on daily sales, so your payments will fluctuate based on what those sales are.

Because a merchant cash advance is not a traditional loan, it is not regulated like a regular business loan. Therefore, interest rates can be extremely high. In addition, these companies may start collecting payments — including interest — the next business day after the receipt of your funds. As such, lenders that offer merchant cash advances often seek out businesses with poor credit histories that cannot qualify for other types of business loans.

The high interest rates and frequent payments can be difficult for some businesses to pay as required, driving them further into debt. However, this can be an attractive option for many businesses given approval can happen in as little time as 24 hours.

How to repay business loans

Repayment for business loans depends on the type of loan obtained. You could make payments through installments, or regular payments, made weekly, monthly or even quarterly. Or payments could be made on a revolving basis, meaning you repay what you borrow. In some cases, payments may be taken out per purchase or business transaction.

Here’s how you can expect to make payments depending on which type of business loan you get:

  • SBA loans, term loans and equipment financing: The borrower makes regular payments as agreed upon with the lender. These could be weekly, monthly or quarterly.
  • Invoice financing and business lines of credit: These are revolving financing options, which means you are preapproved for a set amount that you can borrow against. When you repay the amount borrowed, you can then borrow those funds again, and the cycle continues.
  • Merchant cash advances: The borrower repays this business loan by giving the lender an agreed-upon percentage of each debit or credit transaction it completes until the loan has been repaid.

Business loan requirements: How to get a business loan

1. Build your personal and business credit scores

Because business loan requirements may look at both your personal and business credit score, you need to build your credit scores by making regular, on-time payments on your existing loans and credit cards, as well as keeping your debt level low.

2. Research lenders and check requirements

Getting a business loan that’s right for your business means finding a lender and loan qualifications that align with your needs and financial situation. Most business loans require a minimum number of years in business, a good credit score and a strong financial history. Some financing options also require collateral.

With regard to SBA loans, the qualification requirements are a bit different. While SBA loans do take into account a business’s ability to repay the loan, lenders also look at how the business makes money, where it operates and if it meets SBA size standards as a small business.

3. Gather documents

To get a business loan, you typically will need to provide the following documents:

  • Loan application form
  • Resume
  • Business credit report
  • Income tax returns
  • Accounts payable and receivable
  • Financial documents, such as bank statements, balance sheet, income statement and cash flow statements
  • Legal documents, such as articles of incorporation, business licenses, commercial leases, franchise agreements and any contracts with third parties
  • Business plan

4. Provide collateral if necessary

While not all business loans require collateral, for those that do, be prepared to provide a collateral document. This should list the cost or value of all personal and/or business property that you are prepared to offer to secure the loan.

Where to get a business loan

Banks

Large commercial and community banks offer a wide array of business loans, often with terms that fit your needs as well as lower interest rates than other lenders. However, their requirements may be stricter and the application process can be lengthy, requiring a lot of paperwork and documentation as well as a long time for review and approval.

Because they are generally smaller, community banks can sometimes offer more personal service and be more willing to work with a business to get approved for a loan than a larger commercial bank.

Online lenders

Small business loans through online lenders, such as Rapid Finance and OnDeck, often are easier to get approved for because these lenders are more likely to work with borrowers that have less-than-perfect credit, have not been in business for very long and/or don’t have large annual revenues. Additionally, the application process is typically quick, sometimes taking just a day, with funding received in as little time as one to two days after approval.

On the flip side, online small business loans often have higher interest rates, shorter repayment terms and lower borrowing limits than traditional lenders.

Bank lenders backed by the SBA

The SBA works with major lenders, such as Wells Fargo and Chase, to provide loans to businesses at lower rates with long repayment terms. These lenders take on these loans because they are guaranteed by the SBA, which will pay off a portion of the loan should the borrower default. However, businesses must meet a unique set of eligibility requirements to receive an SBA loan, which can be hard to do.

Peer-to-peer lending sites

Peer-to-peer loans are loans between an investor, rather than a bank, and the borrower. Examples of peer-to-peer lenders include Upstart and Peerform.

Peer-to-peer lending can be a good option for new businesses or those with poor credit.

Qualification requirements vary by lender. Upstart, for example, requires a minimum credit score of 600, while Peerform requires a minimum score of 600. It’s important to check with different lenders for exact qualifying requirements.

While approval may be easier, these loans also may have very high interest rates and origination fees.

FAQ and other things to know

Loan approval can range from just a few days when applying with an online lender to one to two months when applying for a term loan through a bank or SBA-approved lender. Loan approval for a merchant cash advance also can be quick, while approval for a line of credit may take a week or more.

Business loan terms vary based on the type of loan you have. For instance, long-term loans may be for up to 10 years, while short-term loans range between three and 18 months. SBA loans also may have long terms, while invoice financing and merchant cash advances have short terms.

The amount of funding that a small business can get varies based on the type of loan and the individual business’s financial standing. Traditional loans can be for very large amounts — the SBA offers loans up to $5 million — while short-term loans, invoice financing and merchant cash advances have much lower borrowing limits. For instance, invoice financing is based on your outstanding invoices, so if you have an average amount of $2,000 in outstanding invoices each month, your loan would be based on this amount.

Getting a business loan that fits your needs depends on a number of factors. Traditional business loans and lines of credit usually require a solid credit history, several years in business and, in some cases, collateral. Other financing options, such as invoice financing and merchant cash advances, are more likely to provide loans to newer businesses and those with less-than-perfect credit.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

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Banking

Is It Wise to Have Multiple Savings Accounts?

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It may not have been previewed, commissioned or otherwise endorsed by any of our network partners.

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Many adults do not have money tucked away for emergencies, let alone planned expenses. A 2018 report from the Federal Reserve found that about one-quarter of families have less than $400 in available liquidity, and about 60% of families do not have at least three months of expenses saved up.

As such, the prospect of having multiple savings accounts can seem daunting. And, if not set up correctly, it can be.

However, there are many benefits to having more than one savings account, which can help you achieve your short- and long-term savings goals.

Should you have multiple savings accounts?

Multiple savings accounts can be valuable financial tools provided you are willing to take the time and effort to set up and monitor them on a regular basis. Because there’s not always a limit to how many savings accounts you can have, at your bank or elsewhere, you have the option to tailor them to your savings goals.

For instance, you can open up to 19 online savings accounts at Alliant Credit Union. Delta Community Credit Union permits members to open an Additional Savings Account to save for special purposes. At Wells Fargo and Bank of America, you can open as many savings accounts as you like.

But if you are not an organized, detailed person, mismanaging multiple accounts could result in hefty fees and lost opportunities for interest, not to mention failing to achieve your savings goals. Know your limitations so that if you set up multiple savings accounts, you will find the right number that works for you.

Why it’s smart to have multiple savings accounts

Multiple savings accounts can serve a multitude of purposes, from separating your money to optimizing interest rates. Spreading your money around also has many benefits that you may not get with all your eggs in one basket.

Set and achieve savings goals

Depositing your money into one savings account can make it difficult to determine when you have enough funds for a specific savings goal, such as buying a car or paying for a vacation. By setting up a savings account for each goal and labeling that account with the goal’s name or a nickname, you can clearly see how much money you have saved toward that goal, as well as when you reach your target.

Provide a safety net for your checking account

Many banks and credit unions, such as Chase Bank and Chime, offer overdraft services that automatically make transfers from a savings account to a checking account to cover overdrafts. This could save you fees for insufficient funds or returned checks, among other things. For instance, Citi charges a $34 insufficient funds fee, while Ally charges $25 as of the date of publishing.

Increase your number of withdrawals

At most banks and credit unions, certain types of telephone and electronic withdrawals, including transfers from savings accounts, are allowed up to six per statement cycle, per the Federal Reserve’s Regulation D.

Banking institutions may impose penalties if you make extra withdrawals from a savings account. Additional withdrawals can incur substantial fees. A bank may even convert your savings account to a checking account or close the account altogether. However, you can increase your number of available withdrawals by setting up multiple savings accounts at different banking institutions.

Take advantage of interest rates

Like other financial investments, savings accounts typically offer interest, which can vary. Currently, the average APY on savings accounts is 0.28%. However, higher rates are available, such as 0% APY with the CIBC Agility Online Savings Account and 0.80% APY with the Barclays Online Savings account.

“Banks often go through phases when they are more or less competitive with their rates,” said Ken Tumin, founder and editor of DepositAccounts, which, like MagnifyMoney, is owned by LendingTree. “So by having multiple savings accounts, it can make it easy to move money to the account that offers the highest rate.”

Such a move could help you grow your money at a faster pace.

Make transfers easier

Having multiple savings accounts at the same institution where you have existing financial accounts or products makes it easy to move your money around.

For instance, you can set up automatic deposits to your savings account from your checking account, which helps keep you on track for reaching your savings goals. Or, if you have one or more certificates of deposit (CDs) at a bank, once a CD matures, you can easily transfer those funds into your savings account, Tumin said.

The challenges of managing multiple savings accounts

While the benefits of multiple savings accounts can be great, there also could be some pitfalls. Before setting up any accounts, it’s important to weigh the pros and cons to know what you’re embarking on in your financial journey.

Tracking and monitoring the accounts

If you are not a detail-oriented person, trying to keep track of several savings accounts can be confusing and overwhelming. It’s important to have processes in place to help you maintain a clear picture of all your accounts.

For example, maintaining a spreadsheet listing each account, the account’s balance, deposits, withdrawals and any fees can help provide an instant status of each account, provided the spreadsheet is updated regularly.

Maintaining minimal balances

While opening a savings account can be easy, banks and credit unions often require a minimum balance, such as $100, to earn interest and avoid incurring fees.

In some instances, you can continue to maintain those accounts if the minimum balance drops, but you may incur fees. That can be tricky if you are more focused on one savings account than another.

Paying higher fees

Some banks and credit unions waive fees on savings accounts if you maintain a minimum balance or have a minimum amount direct deposited into the account each month. Failure to meet those guidelines could result in high fees.

For example, depending on the type of savings account, Chase charges between $5 and $25 a month if the required guidelines are not met. Likewise, if you make more withdrawals a month than allowed, you could be charged hefty fees for each withdrawal beyond the maximum permitted.

Losing time to transfers

If you have multiple savings accounts at the same bank as your checking account, transfers could occur quickly — in one day or less.

However, if you have multiple savings accounts set up at other banking institutions or credit unions, moving money from a savings account at a credit union to a checking account at a separate bank could take two days or more, making it difficult to access your money when you need it.

How to effectively use multiple savings accounts

When setting up multiple savings accounts, it’s a good idea to use different banking institutions to expand your Federal Deposit Insurance Corporation (FDIC) coverage beyond the legal limit.

“You can extend deposit insurance by at least $250,000 for each additional bank that you have,” Tumin said. That insurance coverage is not expanded if you have multiple savings accounts at the same bank.

Also, make sure you have online access to each account and log in at least once a month to view your statements, Tumin said. This allows you to confirm that any automatic deposits are being made and to follow up on any unexpected fees. Online access also makes it easy to electronically transfer funds between your savings accounts and your checking account.

Remember to set up alerts on each account to notify you when withdrawals are made or if your balance drops below a preset level. This could help you avoid unnecessary fees.

When reviewing the savings accounts’ policies, find out if there are any penalties for inactivity.

“Make sure you set up automatic transfers that occur once a month that will keep the accounts active,” Tumin said.

Final word

Having multiple savings accounts could go a long way in helping you build a firm financial foundation and achieve specific savings goals.

However, to make the most of these accounts, take care to set them up so they benefit you, and monitor them regularly to keep on track.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

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Mortgage

How to Get a Home Equity Loan After Bankruptcy

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It may not have been previewed, commissioned or otherwise endorsed by any of our network partners.

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Recovering your financial standing after bankruptcy can feel like an uphill battle, but it could be easier than you think. Take it one step at a time, and you can do it. And if you are looking for a home equity loan, there still may be good options for you to get the money you need.

Home Equity Loan versus HELOC

Before filling out any loan applications or even talking with lenders, it’s important to know the difference between a home equity loan and a home equity line of credit, or HELOC. Although both rely on your existing home equity for collateral, they do not operate in the same manner.

With a home equity loan, you receive the full value of the loan upfront, which you will repay over a set period of time with a fixed interest rate. How much you can borrow is limited to 85% of the home’s equity. As with all loans, how much you qualify to borrow is based on several factors, including your income, credit history and your home’s market value.

Home equity loans also include many fees, such as application or loan-processing fees, appraisal fees, origination fees, document preparation fees and recording fees, among others.

HELOCs operate much like a credit card; as a revolving line of credit, you will be given a maximum amount you can borrow (the credit limit). However, unlike a home equity loan, you don’t have to take all of the money upfront. Instead, you can withdraw as much money as you need when you need it, usually by writing a check or using a debit card connected to the account.

You will be charged interest only on the amount you borrow (the balance due), and you will make payments only on the amount borrowed rather than the total amount available (credit limit).

While HELOCs vary in nature by lender, you may be able to borrow up to 85% of your home equity. Unlike a home equity loan that provides the homeowner with the full loan amount upfront and must be repaid within a specific timeframe, a HELOC may operate with a more fluid schedule. You may be able to withdraw funds at any time for a certain time period, making payments on that balance along the way, or your draw period may be open for a fixed time, at which point you’ll be required to repay the outstanding balance.

HELOCs also incur a variety of fees at the onset, including application fees, appraisal fees, a title-search fee and so on. HELOCs may also have ongoing fees like a transaction fee each time you withdraw funds.

Remember that with either loan option, your home is the collateral you offer to ensure that you will repay the loan. If you fail to pay as agreed, you could be forced to surrender your home to pay off the debt.

What loans are available if you have filed for bankruptcy?

Before looking at available loans following bankruptcy, it’s important to note the difference in types of bankruptcy filings as they affect your loan options. With a Chapter 7 bankruptcy, you liquidate your assets and use the proceeds to repay your debts. Some exemptions permit you to keep specific personal property. Once the bankruptcy is processed, your debts may be “discharged,” or written off, which means you are no longer required to pay them.

Under a Chapter 13 bankruptcy, you agree to set up a plan to repay all or part of your debts. Although a Chapter 11 bankruptcy may be an option, this category of bankruptcy is typically used to reorganize a business, making it a better choice for small-business owners rather than individuals. It is used for businesses that want to keep their companies active and pay their debts over time.

When applying for a home equity loan or HELOC, you won’t be able to do so right away. In some cases, you might be able to qualify for one of these loans three years after your bankruptcy is discharged, but, in general, it’s more common to wait for five to six years to receive loan approval.

If you are looking for a Federal Housing Administration, or FHA, loan, you’ll have to wait for a minimum of two years per the FHA Guidelines if you filed a Chapter 7 bankruptcy. For those who filed a Chapter 13 bankruptcy, you will need a verified record of your repayments for at least one year, as well as the court trustee’s written approval for the loan.

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Tips on repairing credit after bankruptcy

As you consider applying for a home equity loan, the best step you can take right now is to repair your credit standing. A bankruptcy can stay on your credit report for up to 10 years, but it doesn’t have to overshadow your creditworthiness as a valued borrower. There are simple tips you can follow to help you rebuild your financial foundation, making you a good risk for lenders.

Pay on time: The best day-to-day effort you can take to rebuild your credit is to pay all your bills on time. Avoiding late or missed payments goes a long way toward boosting your credit score and showing your commitment to paying your debts.

Create and follow a budget: Setting up and adhering to a budget will help you manage your money better, which can help prevent the need to take on additional debt.

Apply for a secured credit card: Similar to a prepaid credit card, a secured credit card operates based on money you pay upfront, then draw upon as needed. Using this card and “repaying “ the amount used each month can help establish a good credit history on your report.

Apply for an unsecured credit card: After your bankruptcy is discharged, you may start to receive offers for unsecured credit cards — traditional credit cards that don’t require a deposit. Using one of these cards could be beneficial, if properly managed. First, if you use the card for a small purchase each month — for instance, a tank of gas — and pay that balance off every month, you’ll build up a good history of regular payments. Second, it can improve your credit utilization ratio; this ratio looks at how much available credit you have versus how much credit you use each month. If you have $1,000 in available credit and use $100 of that credit each month, your credit utilization ratio is 10%, which is below the preferred maximum ratio of 30%.

Have someone cosign on a card or loan: You can draw upon a family member or loved one’s good credit by having them sign onto a credit card or loan with you. Their good credit history can help you get the card or loan, but your credit will receive a boost when you pay the card or loan as agreed each month. There is a drawback, though, if you fail to pay the debt as they will be responsible for covering the payments for you.

Final thoughts

Keep in mind that you will need to make changes in how you approach financing and managing debt in order to stay out of the trouble that led to bankruptcy. As such, it’s imperative for you to consider all of your options to see if a home equity loan or HELOC is the right option — or even necessary — for you.

It’s especially important to note that interest rates are on the rise, which could make home equity loans or HELOCs more expensive. Also, with the changes under the federal Tax Cuts and Jobs Act (TCJA), enacted in December 2017, the tax benefits of a home equity loan or HELOC may no longer be available or beneficial for you. Evaluate the additional factors before deciding to apply for these loans.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

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