Business Lending Q&A: Business Loans, Business Overdrafts, and Commercial Mortgages Explained

Business Lending Q&A: Business Loans, Business Overdrafts, and Commercial Mortgages Explained

Whether you’re entering into a brand new enterprise or you’re an established business owner, it can often feel difficult to get to grips with the world of business lending. With so many lending options available to businesses, finding out which types of financial support are available may seem a hassle, not to mention determining whether you’re even eligible for business lending.

However, with our Q&A, we’ve put together some of the most frequently asked questions about business loans, business overdrafts, and commercial mortgages, to help you get your head around the world of business lending.

Q: What is a Business Loan?

A business loan is a sum of money lent to a business over a specific period of time by a separate party, usually a bank. The time period varies from lender to lender, and also is dependent on the specific circumstances of those borrowing the money. Business lending can be short term or long term, depending on why and how the business will be using the money. The loan is paid back in instalments over a pre-agreed time period, which can range from as short as 1 year, to longer periods up to around 25 years.

Q: Why take out a business loan?

One of the main reasons a business may look for outside lending is to supplement and support cash flow. By having a separate source of income, in addition to profits, a business can give itself a buffer in the eventuality that the expected incomings do not surface.

Business loans are often taken out to support payment of property or assets. This allows a business to quickly gain new premises or necessary equipment without having to put down an initial payment out of its own pocket. This way, the premises or assets can be paid back over a set period of time, rather than in one lump sum.

Another reason someone may turn to business lending is to get help to fund the costs of starting up a new enterprise. In this case, some banks may offer start up specific lending, generally short-terms loans and commercial mortgages.

Q: What types of business loan are there?

There are many types of business lending available to account for the varying sizes, needs, and purposes of businesses.

A small business loan is the smallest amount generally able to be borrowed from a lender. Small business lending is open to all types of businesses, from sole traders to limited companies, and is also a popular source of funding for start-ups and entrepreneurial enterprises in their formative periods. This type of lending is often used as a short term cash flow injection, used to purchase assets and equipment. Small business loans usually have fixed costs, allowing businesses to budget and repay the loan effectively and efficiently. Many banks implement early repayment charges on small business loans, meaning a business may have to pay a fee if the loan is paid off before the pre-agreed lending period comes to an end.

Fixed rate business loans ensure that a business will pay a fixed rate of interest on the loan over the period of its duration. Fixed rate loans allow a business to borrow a larger amount than a small business loan, so are typically aimed at medium to large size businesses who can demonstrate they have a secure cash flow history. Another key difference to a small business loan is that fixed rate business loans may have no early repayment charges, making them a good choice for businesses wanting more flexibility.

A variable rate loan is a business loan with a varying interest rate. In the UK, this interest rate is set by the Bank of England base rate or London Inter Bank Offered Rate (LIBOR). They are the most long term business lending available, with many high street banks offering a payment and repayment period of up to 25 years. Due to the long term nature, large amount of money able to be borrowed, and lump sum repayment method, variable rate loans are generally only offered to established businesses.

Q: How do I find out if my business is eligible for a loan?

Before you’re able to take out a loan, your eligibility will need to be assessed. This helps a bank or lender decide whether you’re suitable for business lending, but can also help you decide what type of lending (if any) is best suited to you.

Depending on the size or age of your business, eligibility will be assessed in a number of ways. It’s common for a credit check to be undertaken to ensure that you’ll be able to repay whatever amount you’re expecting to borrow.

If you’re an existing business owner, the past and predicted performance of your business may also be assessed, looking at previous and expected outgoing and incomings. Again, this ensures that your revenue forecasts are in line with the amount you’ll be borrowing and repaying.

It’s also useful to inform your bank about what you plan to use your loan for, as they may be able to point you in the direction of the type of lending best suited for this. For example, if you’re looking for a quick cash injection, it’s highly unlikely that you’d need a loan. Equally, an overdraft would not be suitable for a business looking for money to support a programme of long term growth and expansion.

Is a business loan the only type of business lending?

As well as the varying forms of business loans listed above, other options do exist for businesses looking for financial support.

Many high street banks offer current accounts with an arranged business overdraft, often aimed at SME’s (small to medium sized enterprises). Business overdrafts are typically small compared to business loans. Rather than being a source of capital to supplement a business’s earnings, an arranged overdraft is designed more to bridge a gap between outgoing and incoming capital. Some banks may offer business current accounts with no overdraft fee; however, this is usually only for a limited time, and interest is likely to be charged after this period if the overdraft is used.

Another common type of lending banks offer businesses is a commercial mortgage. Commercial mortgages are designed to support businesses in the purchase of new property, and thus the amount borrowed is larger than most business loans.. Like business loans, a business will need to be assessed in terms of its trading history in order to take out a commercial mortgage. Commercial mortgages are paid back over long periods of up to 25 years, and are available with fixed or variable interest rates.

It is always possible to start a small business–in particular, a home business–by taking out a personal loan from a bank. It is usually better to find an unsecured loan so that if your business venture goes south you won’t lose your collateral. However, if unsecured personal loans are unavailable, you can always try to find a secured loan. For example, someone looking to start up a home-based business might look into a home equity loan, which involves using your home equity as collateral.

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