8 Life-Saving Tactics When Taking Out a Business Loan

Anyone even slightly involved in commercial activities knows how difficult these tasks can be. Finding financing to grow your business, buy new machinery, strengthen your inventory, or manage that challenging cash flow is often challenging. At this point, the first solution that comes to mind is often a commercial loan. Approaching banks is one of the most important steps toward expanding your business. But before signing, it’s important to pause and think carefully. There are important points to consider when taking out a business loan. In other words, while trying to take your business to the next level, making the wrong choice can impose a burden you can’t afford and clip your wings.

Many businesses apply for loans due to urgent cash needs without focusing on the details. However, these hasty decisions can lead to financial difficulties and a spiral of debt in the long run. In addition to interest rates, unseen costs related to the loan, such as additional insurance costs, filing fees, and early closing penalties, can erode a company’s profits and disrupt its cash flow. Therefore, the loan agreement should be thoroughly reviewed, and every clause should be understood.

Another important consideration is the reliability of the lending institution. While non-bank financial institutions or private finance companies may offer seemingly attractive offers, they can also pose a high risk. It’s crucial to investigate whether these institutions are regulated, whether the loan they offer is legally valid, and whether the repayment terms are clear. Transparency and trust in commercial loans are essential for long-term business success.

Now, let’s analyze what lies behind those formal and complex bank contracts from a business owner’s perspective. Here are eight golden rules that will help you sign with peace of mind and protect you from potential pitfalls when taking out a business loan!

Just the Interest Rate? The Total Repayment Cost

That bright, low interest rate we see in bank advertisements or initial offers is often just the tip of the iceberg. Many business owners make the biggest mistake by focusing solely on this rate. However, what you really need to consider is the total cost of repaying the loan. This cost isn’t just principal and interest. It includes dozens of seemingly “hidden” or “small” costs like filing fees, appraisal fees, mortgage origination fees, life insurance, and business insurance, but when combined, they add up to a significant sum.

When you get a quote from a bank, ask them to clearly show not only the interest rate but also the “total monthly and annual cost ratio.” This ratio is legally required and provides the most accurate representation of how much the loan will actually cost, including all additional costs. Compare offers from different banks based solely on this total cost ratio, like comparing apples to apples. A loan with a 1% lower interest rate may be more expensive than another, including insurance and fees.

Pay particular attention to insurance. Banks may require you to take out various insurance policies (life insurance, business insurance, DASK, etc.) to protect themselves. The insurance policy offered by the bank itself may often be higher than the market rate. Remember, you are legally entitled to obtain insurance from the insurance company of your choice.

When taking out a business loan, you can significantly reduce this cost by obtaining quotes from different insurance agencies. This is your legal right, and don’t hesitate to insist on it.

Be a Detective and Don’t Forget Your Credit Score!

Filing fees and fees are another important consideration. Some banks offer low interest rates but may initially charge a high fee or filing fee. Be sure to ask if these costs are negotiable. Banks will be more willing to reduce or eliminate these fees, especially if you have a good credit score and a solid financial standing. Remember, a bank is also a business that wants to do business with you. You shouldn’t forget to improve your credit score.

Ultimately, when searching for a business loan, you should be like a detective. Focus on the entire package, not just the flashy interest rate on display. Never move on to the next step without a clear answer to the question, “How much will the $100,000 I’m going to withdraw, including everything?” This simple question could save you thousands of dollars in unnecessary costs.

Flexible Repayment Plan and Restructuring

When you take out a business loan, you might assume everything is going well and your business will run smoothly. However, the nature of business is characterized by ups and downs. That’s why the flexibility of the repayment plan in the contract you sign is crucial. Perhaps one day, your business will go much better than expected and you’ll want to pay off the loan before its due date. Or, conversely, a market downturn will require you to defer your payments for a few months, in other words, to restructure your loan. For both of these scenarios, you should understand what the contract stipulates from the outset.

One of the most common problems is the “early repayment penalty.” In many commercial loan agreements, you’ll find that the bank charges you a penalty or commission if you pay off the loan before its due date. This percentage typically ranges from 1% to 2% of the remaining principal. Be sure to find out what this percentage is and whether it’s negotiable when you take out the loan. This requirement may even be a reason to choose between different banks. If you decide to eliminate your debt with a lump sum of money in the future, this penalty can be frustrating.

Let’s consider the opposite scenario when taking out a business loan: your business has gone bad and you’re struggling to make payments. In this case, how flexible is your bank regarding restructuring—spreading the debt over a longer term at a new interest rate? Are the restructuring terms clearly stated in the loan agreement? Some banks are more accommodating in this regard, while others may have stricter rules. Openly discuss this “rainy day” scenario with your loan representative. Don’t hesitate to ask, “What kind of assistance would you provide if I struggle to make payments?” This is also a good test of the bank’s approach to you.

Collateral Taking Out Business Loans: Guarantees

For banks, lending money means taking a risk. To mitigate this risk, they require you to provide collateral, or collateral. One of the most critical factors when taking out a business loan is the type and value of collateral the bank will require. This collateral can typically be a real estate mortgage (business, home, land), a vehicle lien, or a valuable piece of machinery. The first thing to consider here is how much the bank will value the asset you’ll be offering as collateral.

The bank will send an appraisal firm to assess the property it will be mortgaged. The appraisal report’s value can often be slightly below the property’s actual market value. The bank typically doesn’t extend the loan at its full value, but typically at 70-80%. For example, if your shop is valued at $2 million, the bank can only lend you a maximum of $1.4 million to $1.6 million. Therefore, when taking out a business loan, you should first calculate your loan amount and the amount of collateral you can provide.

Guaranteeing is another important point. The bank may request your personal guarantee or the guarantee of another relative for your company’s loan. When you provide a personal guarantee, the bank has the right to claim all of your personal assets (your home, car, and bank funds) if the company defaults. This means the company’s risk is intertwined with your personal risk. You should carefully consider the consequences before taking this step. If possible, offer only the company’s assets as collateral rather than a personal guarantee.

In Conclusion: Commercial Loan Application

As you can see, securing a business loan is much more than simply filling out a form and signing. Taking out a busines loan is a strategic step towards the future of your business, and each step requires careful consideration. Looking beyond interest rates, uncovering hidden costs, requesting a flexible repayment plan, and properly negotiating collateral terms are essential to this process.

Now, let’s list the eight golden rules to follow when taking out a business loan:

1. Conduct a Needs Analysis: Before taking out a business loan, determine exactly how much money your business needs. Overdrawing can lead to unnecessary interest charges, while underdrawing can lead to work being left unfinished. Determine the right amount with a detailed financial analysis and budgeting.
2. Evaluate Your Repayment Capacity: Consider your business’s current and future cash flow and ensure you can make regular payments. Don’t forget to create a buffer for unexpected situations. Thoroughly analyze your debt-to-income ratio.
3. Compare Different Banks and Financial Institutions: Don’t stick with a single bank. Thoroughly compare the interest rates, commissions, maturity options, and repayment terms of different banks and financial institutions. Take your time to find the most suitable and advantageous offer.
4. Choose the Right Loan Type: Determine the type of loan that best suits your business’s needs. There are various types, including working capital loans, investment loans, project financing, and SME loans. Each has its own advantages and disadvantages.
5. Review the Contract in Detail: Before signing the loan agreement, carefully read and ensure you understand each clause. Ask the bank representative about any points you are unclear about or have any doubts about. Pay particular attention to items such as early termination penalties, default interest, and additional costs.
6. Understand Collateral and Surety Requirements: Obtain clear information about the collateral required for the loan (mortgages, liens, etc.) and the collateral requirements. Carefully consider the potential impact of these obligations on your business and personal assets.
7. Consider Additional Costs: Don’t focus solely on the interest rate. Consider the impact of additional costs such as loan origination fees, filing fees, appraisal fees, and insurance costs on the total cost. The true cost is determined by these additional costs.
8. Strengthen Your Business Plan: Just as banks grant loans, you also evaluate your business’s plan and future potential when taking out a business loan. By presenting a comprehensive, realistic, and compelling business plan, you can expedite the loan approval process and secure better terms.

Using these eight rules as a checklist, you’ll be a much more informed, confident, and negotiable business owner when you approach banks. Remember, proper financing isn’t a burden for your business; it’s the most powerful fuel that will propel you toward your goals.

Now is the time to use that fuel wisely!