How to manage an unsecured business loan
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Unsecured business loans are one of the most versatile sources of funding for your business. You can use these loans for anything from paying immediate bills to hiring employees, to investing in growth.
To get the most out of your loan, you’ll need to manage it properly. If you fail to understand the terms of your loan or pay on time, it could cost your business a lot of money, damage your credit and lead to far worse consequences.
To ensure that doesn’t happen, read on to learn more about how to manage your unsecured business loan.
What is an unsecured business loan?
An unsecured business loan is a type of financing that doesn’t require any personal or business collateral. They’re a good fit for business owners with no valuable assets to pledge as collateral or who don’t want to provide assets.
Unsecured business loans are riskier for the lender since there is no collateral it can seize if you stop making payments. That’s why this type of loan can come with higher rates than secured business loans.
What happens if you don’t pay an unsecured business loan?
There could be severe consequences if you miss payments. Once you miss the due date for payment, your loan will enter delinquency. When this happens, the lender may assess late fees and other penalties.
If you miss payments for multiple months, your business loan goes into default. When this happens, the lender could use the loan’s acceleration clause to demand full repayment immediately. The lender could also bring legal action against your company to force payment, and if you signed a personal guarantee, your personal assets could be up for grabs.
Missed payments and loan defaults can also damage your credit, dropping your score and leaving negative marks that stay on your credit report for seven years. That’s bad because bad credit can make future borrowing difficult and expensive.
To avoid the negative consequences of taking out a business loan, here are some tips to help you manage your business loan successfully.
Read your loan agreement
Before you sign any legal document, it’s important to make sure that you read it carefully and fully understand it.
Your loan agreement will outline the details of how your loan works, such as how interest is calculated, when your payments are due and any loan fees. It also describes what happens if you happen to miss a payment or have other problems with the loan.
Some common areas to look for in the agreement are:
|Terms and conditions||The basic details of the loan include the amount, the term, the interest rate, and any fees, such as origination or early repayment fees.|
|Penalties for nonpayment||This outlines the fees and penalties you’ll deal with if you miss payments. It may also indicate the loan’s grace period, if there is one.|
|Acceleration clause||This clause describes how the lender can demand immediate payment of the loan’s full balance if you default on the loan.|
Follow a budget
A business budget is an essential tool that gives business owners a true understanding of their financial status and the power to manage their businesses effectively. The budget should describe how much money the company makes, how much it spends, where it comes from, and where it goes.
Make sure that your new loan payment fits in your monthly, quarterly, and annual budgets and update your budgets over time as your situation changes.
Each business will budget in different ways; some popular budgeting strategies include:
|Master budget||This is a single master financial document that contains all of the company’s financial information, usually for a full year. It may have various lower-level budgets that focus on specific things, like labor or sales budgets.|
|Operating budget||This is a basic method of budgeting that looks at a company’s revenue and expenses over a period of time.|
|Cash budget||A cash budget looks at a business’s cash inflows and outflows over a period, such as weekly, monthly, or quarterly.|
|Zero-based budget||Zero-based budgeting sets the budget for every spending category at $0 at the beginning of each period. You then must justify the spending each period. This is a useful method for making sure your company uses funds as effectively as possible but takes a lot of effort to implement.|
Pay your bills on-time
Paying your bill on time avoids additional fees, penalty interest rates and damage to your credit. Given the importance of timely payments, consider setting up automatic loan payments whenever possible or creating reminders about upcoming due dates.
Should you pay more than the minimum each month?
Paying more than the minimum can be a good idea for some companies. Larger payments mean you’ll pay the loan off sooner than expected and get out of debt sooner. It will also reduce the amount of interest that accrues, saving you money.
But there are cases where it isn’t a good idea. First, check to ensure your loan has no early repayment penalty. If the loan has this penalty, you’ll pay a fee if you make extra payments.
You also have to consider your company’s cash flow. If you put too much money toward loan payments, you might not have enough to cover other expenses. You’ll also want to consider opportunity cost. You might be able to use your extra cash more effectively, generating business growth that leads to more profits than the money you’d save by making extra loan payments.
Avoid having too much debt
Some debt isn’t necessarily a bad thing. Proper use of credit can help you grow your business more quickly, and you can use your new revenues to make loan payments.
But if you borrow too much, you could be left with large loan payments that are hard to make. You’ll also face large interest charges and a dip in your credit score.
It’s better to limit your borrowing and grow at a slower, more sustainable pace than to try to borrow too much and put pressure on your company to make big loan payments.
Check your credit
Before applying for any loan, check your personal and business credit score. See if there are any errors on the report that you can get removed or if there is anything you can do to give your score a quick boost. That can help you secure a lower cost for your loans.
You should also monitor your credit score as you are paying off your loan to make sure you are quickly correcting any issues that arise and avoiding errors that could damage your score.
Talk to your lender
If you run into problems and feel like you might struggle to make loan payments, it’s better to reach out to your lender sooner rather than later. Many lenders are happy to work with you to help you manage your debt and would prefer that to you suddenly missing payments and going into default.
Your lender might be able to help you by offering a deferment or forbearance, giving you more time to come up with the funds to make your payments. They could also work with you to consolidate debt, restructure debt, refinance it, or in the worst case, settle for less than you owe.
Business loans are an important tool for companies that need extra cash to cover their expenses or grow their business, but they’re a tool that comes with some risk. Use these principles to make sure you manage your loan properly and you’ll avoid unnecessary fees and interest charges.
Frequently asked questions
Sticking to a budget and making on-time payments are the best ways to pay off your business loan. If you follow the minimum payment schedule, you’ll pay the loan off at the end of its term. If you make larger payments than the minimum, you’ll pay it off early.
Yes, SBA loans have prepayment penalties that only apply to loans with terms of 15 years or longer. The fee is:
- 5 percent of the prepaid amount in year 1
- 3 percent of the prepaid amount in year 2
- 1 percent of the prepaid amount in year 3
The loan amount you can borrow for your business depends mostly on your company’s size and revenue. A common rule of thumb is that you can borrow a maximum of 10 percent to 30 percent of your business’s annual revenue.