You’ll encounter many terms when searching for a business loan. In this guide, we’ll walk you through all the essential terms related to small business loans. Understanding these terms equips you to navigate the loan process, choose the right financing option, and negotiate more favorable terms with lenders.
Interest and Fees | |
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Annual Percentage Rate (APR) | The APR is the annualized cost of a loan or credit, expressed as a percentage. APR includes not only the interest rate, but also other fees and costs associated with the loan. It provides a clearer picture of the total cost of borrowing and is useful for comparing loan offers. |
Interest Rate | The interest rate is the percentage of the loan principal charged by the lender for borrowing the funds. It can be either fixed (stays constant) or variable (fluctuates based on market conditions). |
Amortization | Amortization refers to the process of paying off a loan over time in equal installments. Each payment covers both principal and interest, with the interest portion decreasing and the principal portion increasing over time. By the end of the loan term, the loan is fully paid off. |
Balloon Payment | A balloon payment is a large, lump-sum payment that is due at the end of a loan’s term. Throughout the loan, the borrower makes smaller, regular payments, and the remaining balance is paid off all at once at the end. Balloon payments are common in loans where initial payments are lower to accommodate cash flow needs. |
Prepayment Penalty | A prepayment penalty is a fee charged by a lender when the borrower pays off the loan early, either partially or in full. Lenders use this to recoup the interest income they would have earned had the loan been paid off over the agreed-upon term. |
Loan Security and Guarantees | |
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Collateral | Collateral is an asset that a borrower pledges to a lender as security for a loan. If the borrower defaults, the lender can seize the collateral to recover their losses. Common examples of collateral include real estate, equipment, inventory, or vehicles. |
Blanket Lien | A blanket lien is a type of lien that gives the lender the right to claim all of a borrower’s assets as collateral if the borrower defaults on the loan. It covers multiple assets, unlike a specific lien that is limited to one asset, such as a vehicle or property. |
Unsecured Loan | An unsecured loan is a type of loan that does not require any collateral. Instead, the loan is granted based on the borrower’s creditworthiness and financial history. |
Secured Loan | A secured loan is a type of loan that requires the borrower to provide collateral to secure the loan. If the borrower defaults, the lender can seize the collateral to cover the debt. |
Personal Guarantee | A personal guarantee is a legal commitment made by a business owner or individual to repay a loan personally if the business cannot. If the business defaults, the lender can go after the guarantor’s personal assets (like savings, home, or investments) to recover the debt. |
Here are a few key terms that may not be immediately obvious when considering business loans, but they will arise when discussing specific loan terms. Small business owners must be aware of and understand these terms, along with industry standards, to secure the best possible loan offer.
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