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Taking out an SBA loan is a great option for many business owners. Whether you are aiming to grow your company or just stay afloat, having a small business loan is an essential tool for a business owner. However, it is crucial that you that you can afford to make the loan payment. Read on to learn about the facts you need to know when taking out an SBA loan.
Understand What a Personal Guarantee Means
Almost every small business loan will require a personal guarantee form the business owner unless the loan is 100% secured by cash. Key employees that are vital to the business will be asked to guarantee and they are to be taken seriously. By granting a personal guarantee you are promising to repay the loan from personal assets if the business cannot pay. This means you will pay out of your own bank account even if the business is closed.
Many small business owners believe that if they form a legal entity like an LLC, Sole Proprietorship, S-Corp, etc., it means they will be protected from personal liability when it comes to the SBA loan they have. If you did not sign a personal guarantee, this is true.
Understand Pledging Collateral
If you have equity in your home, the lender will most likely ask you to pledge it as collateral. The reason lenders do this is just in case things do not go as planned. You could face foreclosure if your state allows lenders to take a primary residence as collateral and the loan is not repaid. Even if the bank chooses not to foreclose, a bank lien will make it difficult for you to sell or refinance the home.
Understand You are Stuck with Partners
Businesses closing over partner disputes is a common scenario and disagreements can happen. However, it can be difficult to separate. In the eyes of the lender, you both are still on the hook for the loan. This means that even if someone agrees to take over the loan, you are still going to be liable to the lender if the partner fails to commit to making the payment.
You both are responsible to pay 100% of the loan and that means if you can afford to repay 100% of the loan, the lender will expect you to pay.
Determine How Much Funding You Require
It is important that you realize how much money you need. Do not forget to include the fees. Be cautious of taking out a larger loan than you need because the interest will be high, and it will affect your income-to-debt-ratio.
Decide How Fast You Need the Funds
The less urgent your need for the funds is the better options you will have. If you have time before you require the loan, you might be able to shore up your credit score and search for an ideal lender or lower the amount that you need to borrow.
Know Your Credit Score
Your credit score is important when you are trying to get an SBA loan. It is imperative that you make sure there are no mistakes on your credit score that need to be resolved. Request a copy of your credit report before you even consider applying for a loan and ensure that the information on there is accurate. If you find an error, you must contact the credit bureau immediately so that the issue is resolved.
Make Regular Loan Payments
You need to be able to afford the monthly payments for your business loan. Not making loan payments on time can have serious consequences to your business credit rating in the form of penalties from the lender. Make sure you are confident that you can make the payments for the loan even on slow months before you sign the application for the loan.
Lenders use a debt service ratio of 1.5 times your cash on hand at the end of the month to determine the loan payment you can afford. That means when you take the cash you have on hand in your business bank account at the end of the month and divide it by 2.5, the number should be bigger than your loan payment. If the number is opposite, this means you do not have enough cash flow to take on a business loan at this amount.
The Bottom Line
Before you take out an SBA loan for your small business, make sure that you take the time to understand the downsides and worst-case scenarios. It is important that you understand the downsides and worst-case scenarios. The decision to take out a loan can make or break the future success of your small business. Consider all the pros and cons before you make the best choice that will fit your needs.
