How Do Business Loans Work?
Learn about what business loans are and how they work before you apply for finance.
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If you’ve thought about starting your own business or in the near future or scaling up your current operations, you’ve probably considered taking out a business loan. If you're not 100% sure about how they work, though, you can read all you need to know about business finance right here with Savvy in our handy guide.
How exactly do business loans work?
Business loans work by allowing current or would-be business owners to borrow funds from a lender such as a bank, credit union or online lender, which are then used to start, continue or expand the running of the borrower’s business.
The majority of online lenders will only offer credit to businesses that have been running for at least one year and can provide proof that their annual revenue surpasses a certain amount, which is generally between $50,000 to $120,000. Larger lenders such as banks will also extend credit to newly established businesses, as well existing businesses with proven revenues. Approval and funding can be arranged as soon as the same day you apply.
The full loan amount must be repaid to the lender over an agreed-upon period of time, plus interest. This is known as the ‘loan term’ and can range from anywhere between three months to longer terms up to ten years or more depending on the lender’s policies and the borrower’s circumstances. The interest payable on these loans will vary greatly depending on a variety of factors such as the borrower’s financial situation, and projected business outcomes.
Business loans can be either secured or unsecured. A secured business loan requires you to provide an asset or guarantor that can guarantee you lender will be able to recoup any losses in the event that you are unable to make your repayments. Securing your loan can also help to get you a better interest rate and cheaper fees, as well as increasing your borrowing power. An unsecured loan requires no security and is generally much easier and quicker to get, but due to their lenient nature will typically come with smaller borrowing ranges and higher interest rates.
A range of different loan features can be incorporated into business loans, which can make certain loan options more appealing than others to some prospective borrowers. These features can include the capacity to make extra, advance repayments towards your loan, or a redraw facility, which can allow you to access funds which you have already repaid towards your loan.
What will I need to apply for a business loan?
In order to apply for a business loan, you will need to provide the necessary documentation as outlined in the following table.
| Documentation | Details |
|---|---|
|
Official photo ID |
Your government issued ID will need to be one or more of either a driver’s license, passport or adult proof of age card. Others can be accepted also, so check with your lender to ensure that these are suitable. |
|
ABN or ACN |
The Australian business number (ABN) or Australian company number (ACN) associated with your business is your unique business identifier and will need to be provided to your prospective lender. |
|
Financial records |
The financial records required of you might vary between lenders. However, different forms of financial records you should be prepared to provide include:
|
|
New business documents |
If you are taking out a loan to start a new business you might be required to provide a business plan which outlines your projected costs, earnings and timelines. |
If you are unable to provide all of the documentation listed above, you might still be eligible for a low doc or no doc business loan. In this instance, you will still need to provide official photo ID. However, in lieu of bank or cashflow statements, a letter from your accountant or a signed income declaration might suffice. Low doc business loans will typically come with a lower borrowing range, may require security and could come with higher interest rates.
Explained: comparing your business loan options
Borrowing range
The first point of comparison you should look at is the borrowing range offered to you by lenders. You will need to ensure that you are eligible to borrow the amount that you will need to carry out your business goals. Your borrowing range will be impacted by both your current and projected business revenue (and thereby your ability to make your repayments), as well as your credit history and the amount of security you can offer for your loan.
Loan term
You should think about your desired loan term to make sure that this aligns with your business goals. For example, do you wish to open a store and repay your loan within the first two to three years, or access increased liquidity to expand your already large business and work within a longer timeframe?
Interest rate
The interest rate charged by lenders will have a direct impact on how profitable your enterprise will become as a result of taking out your business loan. You should try to find the option with the lowest rate possible that still meets your needs, so as to keep your interest costs as low as you can.
Also, whether you opt for a variable or fixed rate can have a big impact on your business. If the certainty of having consistent monthly repayments on your loan will help with your business’ budget, this can be something you can prioritise. On the other hand, the potential savings to be realised from falling interest rates on a variable rate loan may be more important to you. Make sure that you consider these options before choosing and moving forwards with a lender.
Features
If you feel as though you could benefit from the flexibility that loan features such as a redraw facility or early repayment options can offer you, make sure that these features are offered before committing to one lender. You should also consider whether any additional interest costs or fees which might come with these features are worth it to you.
Fees
The fees associated with your loan can end up being a large portion of your loan costs, depending on your decisions. Compare whether and to what extent different loan options will include fees for:
- Application ($600-$849)
- Annual fee ($0-$750)
- Late payments ($25-$50)
- Early repayments ($0-$450)
- Figures are for a $100,000 unsecured loan.
Secured or unsecured
Because launching a new business is risky, some lenders can require a guarantee that their loan will be repaid. You might find that lenders can offer you a better deal if you are able to offer an asset such as your home or business property as security for your loan. If you are not comfortable with attaching an asset as security, or feel you simply do not need to, consider looking for loans which will not require security.
