8 Types of Business Loans: Which Is Right for You in 2023?
With all the different types of business loans out there, it can be difficult to find the best option for you. Since different businesses have different needs, there’s no one-size-fits-all solution, and the wrong type of loan could mean a waste of time and money in the long run.
In this article, I’ll explain each type of loan. I’ll also walk you through some of the most important things to keep in mind, so that you can make the best funding choice for your business. Here are the 8 most common types of business loans and how to go about choosing the right one.
8 Types of Business Loans
A term loan is the “standard” business loan. With term loans, you borrow a set amount of money upfront and then pay it back, plus interest, over a certain number of months or years, depending on the terms of the loan. You will typically have a set monthly payment and you’ll pay the loan off over time.
Term loans are great if you want a sum of money upfront that you can invest into different areas of your business without it being tied to one thing, such as equipment. You can get a term loan from a brick-and-mortar bank or through an online lender like LendingTree, Rapid Finance, or Biz2Credit.
- Can be used for any business-related purpose
- Rates and terms can be negotiated
- Steady monthly payment and known payback period
- If you have poor credit, you might have to borrow from a short-term lender and pay higher interest
- Might require you to put up some sort of collateral to get the loan
Working Capital Loans (Merchant Cash Advances)
Typically referred to as merchant cash advances (MCA) or working capital, this isn’t technically a loan but rather a cash advance. This means that the lender gives you cash up front that you can use for business expenses as needed, but the way that you pay it back is different from other types of business loans.
With MCAs, you basically sell the lender a portion of your daily credit and debit card sales. This means that until the cash advances (plus interest) are paid in full, the lender will receive a daily portion of everything you sell. This isn’t ideal for many businesses since it cuts heavily into your cash flow, and the interest rates can be very high.
- Low qualification requirements make it an easy way to get cash
- The amount you pay back daily is proportional to how well your business is doing
- Unsecured, so you don’t have to offer any collateral
- Typically the most expensive type of business loan, with rates in the range of 100%-350% or more
- Requires you to give up a portion of your daily sales until the advance is paid off
Small Business Administration (SBA) Loans
As the name insinuates, SBA loans are backed by the Small Business Administration, which is operated by the US government. Since the government backs these loans, you’re required to put up some sort of collateral, whether that’s the business itself or other personal assets that you own.
There are three SBA loan programs that small businesses can apply for:
- 7(a) Loan – This is the most common type of SBA loan, and it’s a good choice for most business needs. Maximum loan amounts can be anywhere from $350,000 to $5 million and terms will vary based on the loan.
- CDC/504 Loan – This is a long-term, fixed-interest-rate loan you can use for large purchases and big renovations. The terms are 10, 20, or 25 years, and the loans are typically capped at $5 million.
- Microloan – As the name implies, this is the smallest type of loan offered under the SBA program. The amounts typically range from $10,000 to $50,000. These loans are perfect for startups and business owners with little collateral that just need a temporary cash boost.
- Backed by the US government so the rates are typically lower
- You can borrow up to $5 million
- Long repayment terms and lower monthly payments
- Secured loan; requires collateral
- More difficult to apply and qualify for than other loan types
Business Lines of Credit
Similar to how a credit card works (more on business credit cards later), a business line of credit is a type of revolving loan. You will have a credit limit that you can borrow up to and then make monthly payments on the amount you borrow. Any amount that you pay off, you can then borrow back immediately as needed, just like with a credit card.
Business lines of credit are great for emergencies since you have money available on tap whenever you need it, but you don’t necessarily have to ever use it. A line of credit can also be used if you need an influx of cash for an opportunity that pops up. Once you pay the balance back off, you’ll have access to that cash again.
- Perfect as an emergency fund
- You only have to pay interest on the amount you borrow
- Used to stock inventory for seasonal businesses
- You may have to pay extra fees for maintenance or making draws, depending on the terms
- Can have higher interest rates unless you have high credit
Invoice Factoring (Accounts Receivable Factoring)
If your business invoices customers, you typically give them between 30 and 90 days to pay the invoice. Issues can arise when you start accumulating unpaid invoices, with little cash flow to stem the tide. That’s where invoice factoring comes in.
With invoice factoring, you sell the unpaid invoices to a factoring company which then collects the money from the customer. You sell the invoices for a lower sum than what the customers owe you. While this means you’ll make less on each invoice you factor, it gets you fast cash when you need it.
- Fast cash when you have too many unpaid invoices
- No money to pay back, no terms to negotiate and qualify for
- You lose money on each invoice you factor
- You lose control over collecting money from your customers, who might not appreciate it
As the name suggests, equipment financing (or equipment loans) can be used to purchase equipment for your business. These types of loans are typically reserved for large-scale equipment, like semi-trucks, construction equipment, etc. Smaller pieces of equipment can be purchased with business auto loans or just regular business loans.
With an equipment loan, the piece of equipment itself is typically offered as collateral to secure the loan. The terms of the loan are also usually adjusted to match the life expectancy of the equipment. The rates that you can expect to get on equipment loans will depend on what the equipment is worth, how much revenue your business brings in, and the terms of the loan.
- You build equity in the equipment as you pay down the loan
- Better rates for equipment purchases than using a standard term loan
- Keeps equipment financing separate from the rest of your business
- Equipment can become obsolete faster than you can pay off the loan
- You typically have to put up the equipment as collateral to secure the loan
- You might need a down payment to qualify for the best rates or even the loan itself
Commercial Real Estate (CRE) Loans
If you want to purchase new real estate for your business, such as an office building, shop, or second location, a commercial real estate (CRE) loan might be your best option. These are somewhat similar to the equipment loans you read about above, except they are to be explicitly used for the purchase of commercial real estate.
Like with the equipment loans, CRE loans will typically require you to put up the property as collateral to secure the loan. Either that or you’ll have to put up an existing piece of commercial real estate, such as your current office building or shop that you operate out of. Lenders will also usually require you to put ~20% down to qualify for the loan.
- Better rates for the purchase of commercial real estate
- You’ll own the property and build equity as you pay down the loan balance
- You have to put up the real estate itself (or other commercial property) as collateral
- You typically need to come up with a sizable down payment on the property
Business Credit Cards
Just like the personal credit cards you might pay most of your expenses with, business credit cards can be used to pay all of your business expenses. In general, business credit cards operate exactly the same as any other credit card. They are a line of revolving credit that you can use up to the credit limit and you only pay back the amount that you actually borrow.
Although the interest rates can be higher than other loan types, business credit cards can be hugely advantageous if you pay them off monthly and just collect all the rewards. Most major credit card companies offer extensive reward programs and the points (or miles) can add up quickly with some businesses’ high spending amounts.
- Revolving credit where you only have to pay back the portion you actually use
- Rewards programs can earn cashback, flights, hotel credits, and more
- Credit card churning can generate tons of points in a short period of time
- High interest rates make it expensive to use credit cards
- Typically has more hidden fees than other types of business financing
Which Is the Best Type of Loan for Your Business?
Now that you have a better idea about the kinds of business loans that are out there, it’s time to take a look at how you can decide which type of loan you need. When you’re in the market for some sort of business funding, you’re going to have a lot on your mind. To decide which type of loan is best for your business, there are three main things that you’ll want to focus on:
- What you need the money for
- How much money you need
- The terms and rates you can handle
With these three things in mind, you’ll be able to go through the different types of business loans above and decide which ones are best for you. Let’s take a quick look at each of these three factors.
What You Need the Money For?
The first thing to consider when you’re trying to figure out which type of business loan would be best is what you really need the money for. This is because for many of the loan types above, the reason that you need the money could immediately disqualify that type of loan right from the start.
For example, equipment and CRE loans (as well as some SBA loans) can only be used for those exact expenses. So if you need to buy inventory for the holidays, you wouldn’t apply for a CRE loan since that wouldn’t be a commercial real estate purchase. Some loans, such as term loans, don’t have any specific purpose tied to them and you can do whatever you want with the funds.
How Much Money You Need?
The amount of money that you need to borrow will have an effect on the type of loan that you want to pursue to begin with. This is because if you need a few million dollars, you likely won’t look for lines of credit, invoice factoring, credit cards, or MCAs since they’re all typically capped at far less.
Conversely, if you just need $20,000 to handle some cash flow issues and make sure you can keep the lights on for another month, then the aforementioned funding types might be the best options for you. Just be cognizant of how much money you’re looking to borrow and think about which types of loans would be best for that amount.
The Terms and Rates You Can Handle
In most cases, you’ll probably want a combination of the lowest interest rates and the longest repayment terms. For the lowest interest rates, you might want to avoid things such as revolving lines of credit or invoice factoring since they’re some of the more expensive types of funding.
On the other hand, specific-purpose loans will typically offer the best rates for that specific reason. So for equipment and commercial property purchases, equipment financing or CRE loans will usually be the best option. Also don’t forget about SBA loans, since they usually have some of the best rates on the market for any type of business loan!
Now that you understand the most common types of business loans, you should have a much easier time deciding which one is best. Just be sure to keep in mind what the money is for, how much money you need, and the rates and terms you’re looking for.