How Does Small Business Loan Work?

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A small business loan is a form of financing designed to help small companies fund a variety of business costs, ranging from buying equipment and supplies to hiring new employees.

Small business loans are available from a number of different lenders. It can be obtained quickly and with low- or no-interest rates, depending on the lender you use.

After you have launched your business, it is natural for entrepreneurs to think of expansion. You can opt for more manpower or look into new and exciting ways.

One of the most common ways to raise capital is through a small business loan. However, what are the things you need to know about small business loans?

Keep reading.

Does a small business loan require collateral?

No, a small business loan does not require collateral. However, the borrower will have to demonstrate their ability to repay the loan on time.

This can be achieved by including income documentation with their application and providing tax returns if requested.

Banks generally do not charge collateral fees or processing fees for these loans. This is why business loans are considered riskier. Unlike personal loans and credit cards, they don’t require any form of collateral.

Do small business loans affect personal credit?

Personal credit is different from business credit. A small business loan is strictly between the business borrower and the lender and is not reported on your personal credit report.

Small business loans are usually small enough that they don’t affect personal credit. This means that other people are unlikely to see the loan on your personal credit report.

However, lenders use credit scoring models that combine a person’s financial circumstances. These include income and assets with the borrower’s behavior with money, as captured in his/her credit file.

They can access such information by having a Business Credit Report (BCR) inquiry made in relation to the application process of the small business loan.

Do I have to deposit a certain amount of money to access the loan?

Generally, you don’t need to deposit a certain amount of money before you can access the loan. However, for a larger amount of money, some lenders do require a down payment.

While the down payment is an upfront cash outlay that a borrower does not enjoy, it is considered an essential part of the loan process.

It shows to the lender that a borrower is serious about gaining and owning property or business under the auspices of a business loan.

Does a small business loan have to be repaid?

Yes. The loan is paid back to the lender by the small business owners in a series of agreed-upon monthly payments that are calculated with specific formulas and parameters.

In some cases, you decide how much and how often to payback based on your cash flow – never more than what’s available.

A small business loan is repaid with interest just like any other loan. However, these companies (and most other types of lending institutions) have the ability to garnish your paycheck should you fail to make payments.

Can a small business loan be forgiven?

Yes. With the help of the SBA (Small Business Administration), your small business loan can be forgiven.

However, for a small business to qualify, the applicant must meet several requirements. Also, there are specific conditions that must be met in order for the loan to be forgiven.

Are small business loans secured or unsecured?

Small business loans are both secured and unsecured. Secured loans are backed with collateral like your home or car, while unsecured loans have no collateral.

Unsecured small business loans may come from banks but also from a variety of other lenders as well, such as venture capitalists or private investors.

They are usually unsecured if they are for business start-up costs, equipment, or short-term needs. Any borrower should consider whether the loan is secured or unsecured before borrowing.

What’s the difference between a small business loan and a grant?

There are many similarities and differences between obtaining a small business loan and receiving a grant.

They may be both financial assistance, but the process for obtaining them is different. Grant funding is administered by government agencies, non-profit organizations, or foundations.

Loans can be obtained through banks or lending institutions. Loans must be repaid with interest.

A small business grant is a non-repayable, non-interest loan that does not need to be paid back. A grant may be used to pay for specific projects or equipment for your business.

Is a small business loan taxable?

The taxability of a small business loan depends on a few factors, including the type of loan you received and whether you were personally liable for the loan.

When applied to income taxes, income is considered taxable regardless of the source. However, it may or may not be subject to all other federal taxes including payroll and self-employment tax.

It is advisable to do your findings thoroughly when deciding to take a business loan for your small enterprise.

What businesses are eligible for small business loans?

In as much the business is for-profit and legitimate, it’s eligible.

Any business involved in the following industries can qualify for loans: agriculture, manufacturing, wholesaling and retailing, construction, hotels and motels, transportation, communications, real estate development, and so on.

However, there are basic requirements to qualify for traditional small business loans. The first is that the business must be profitable. Profitable means that the company had positive gross sales in the previous year and is currently operating at a profit.

Secondly, it must have a steady cash flow. The business must have enough money coming in every month to cover its monthly expenses and loan payments.

Once a business meets these requirements, it can apply for a small business loan according to its needs.

Are small business loans interest-free?

It depends on the loan. You’ll find that business loans made by banks and credit unions typically have interest rates similar to consumer loans, whether it’s for a car, home, or personal use.

There are interest-free small business loans out there from the government and nonprofit organizations. Details vary, so make sure you check with your lender and be aware of the criteria.

What happens if I default?

Defaulting on a small business loan with any particular lender depends on the contract signed at the time of application. The lender may start by trying to communicate with you after missed payments.

In order to prevent a default, communication is important because it allows for a plan of action to pay back the money owed.

There are many ways to handle a default, but it is important that you know your rights as well as your responsibilities while working with a lender.

Ask your lender about defaulting in the future. It’s good to be aware of the responsibilities and risks that come along with defaulting.

Which is better: a traditional bank or online lender?

An online lender may be more attractive to you because they generally don’t require as much paperwork as a traditional bank. Also, a small business loan doesn’t need to be secured by collateral, meaning it’s easier and faster to qualify for one.

However, keep in mind that an online lender could have fewer consumer protection laws than a traditional bank. Or vice versa.

When comparing an online lender versus a traditional bank, consider first the amount you need to borrow and how much interest it will accrue over the lifetime of the loan.

Are small business loans hard to get?

A small business loan can be understandably difficult to obtain. Banks prefer the stability of a well-established business.

Although you may appreciate the benefits this can offer you, they are not always what is needed to get a small business up and running.

If you have a good idea for a business but lack the money to put it into action, banks and some other institution might not give you a loan.

However, there are a number of reliable lenders out there that make small business loans easy for everyone to get.

How long does it take to get small business loans approved?

Small business loans have to go through a process that includes verification of your business’s financial information. This includes your creditworthiness and the strength of your existing sources of capital.

The decision-making process can take up to 15 working days depending on the lender. So, it’s important to submit your loan application with all the relevant documents as soon as possible.

That way, you will get your approval letter quicker and secure the cash you need to run or grow your business.

However, it’s a very long and tedious process if you go through the bank. Approval time for loans from banks can be tedious due to compliance issues that are involved.

Most banks have a process that takes between 3-4 weeks and requires your assent through extensive paperwork. Especially if you are a new business or have not been in business for a few years.


A business loan might be the answer you’ve been looking for if you’re looking to expand your small business.

Sometimes, you have no choice but to borrow money if you want to start a business or expand your existing one. However, getting a firm grasp of all that small business loans entail is important if you don’t want to regret moving forward.

In fact, establishing whether applying for a small business loan is the right move for your enterprise is important. It requires conducting copious amounts of research and knowing exactly what the loan entails.