Types of Business Loans: Which One Is Right for Your Business?
Written by
Aja McClanahan
Edited by
Levi Leidy
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One of the biggest issues small business owners face is access to sufficient capital. Business owners who don’t research their options might end up depending on funds from sources that are impractical or illegal such as student loans, bad credit business loans, payday loans or other short-term loans that end up being very expensive to service.
To avoid this, business owners should look into loans with terms that agree with their business and which are financially sustainable. Here’s a closer look at what types of business loans are out there and the pros and cons of each.
Understanding Business Loans
Business loans provide funding for startups, business expansions, equipment, inventory and other such necessities. These can be short term or long term, secured or unsecured and offered by banks, credit unions, online lenders and the government — there are many different types. Determining which one works best for your business involves some research, but is worth it in the long run.
Common Types of Business Loans
Here are some main types of business loans you should know about.
Term Loans
A business term loan is a specific, lump sum of money disbursed with a set interest rate. It’s amortized over a specific time period so you know exactly how much each loan payment is along with a breakdown of the principal and interest paid down each period (usually monthly).
A term loan is ideal if you’ve got a larger purchase you need to make for your business, like real estate, equipment or inventory. The key here is that you’d want to finance assets you’re pretty sure will earn a return on investment. Otherwise, you could be on the hook for a loan that you are unable to pay back.
| Pros | Cons |
| Set monthly payments | You need very good/excellent credit for best rates |
| Can be used for multiple business needs | Interest adds to cost |
| Multiple lenders offer it | Can require collateral |
SBA Loans
SBA loans are guaranteed by the U.S. Small Business Administration, which allows banks to lend money to business owners at lower rates while providing more flexible repayment terms. There are several types of SBA loans, so you’ll need to consult with local banks that offer this product for information on qualifying criteria. Popular options include SBA 7(a) loans (general use), SBA 504 loans (real estate/equipment) and SBA Microloans (for startups).
SBA loans are good for business owners who have invested their own time and money into their business, yet have no other options for business financing. Additionally, you’ll have to meet lender eligibility requirements (which vary by lender) and be willing to offer up collateral for the loan, such as business and personal assets in some cases.
| Pros | Cons |
| Lower interest rates | Long approval process |
| Longer repayment terms | Requires extensive paperwork to apply |
| Lower requirements for down payment | Often requires collateral |
Business Line of Credit
A business line of credit is a bank loan similar to a credit card in that it provides access to financing on a continual basis.
You might want to use this business loan for lags in cash flow that are large and might last a few months. This loan is also ideal because when there’s no balance you won’t need to make payments or pay out any interest. It’s convenient and can be used when needed, but doesn’t require a brand-new application each time you need to borrow money.
| Pros | Cons |
| Only pay interest on what’s borrowed | Higher rates than term loans |
| Can be reused, much like a credit card | Credit limit may be lower than desired/needed |
| Helps manage unpredictable costs | You need strong business credit for good terms |
Equipment Loans
This term loan is collateralized by the equipment you’ll buy with loan funds. This makes the loan less risky for the bank, as it could conceivably sell the asset to recoup any losses on the loan. Less risk usually translates into better terms, like a lower interest rate, for the borrower.
These business loans are ideal for business owners who need to purchase equipment that is vital to the profitability of the business. Think about a bakery that might need commercial ovens or a construction outfit that needs specialized excavating equipment.
These loans are not good for business owners who don’t have a good credit profile. Banks typically choose not to extend financing to business owners with bad credit in this scenario. If they do, the terms might not be favorable.
| Pros | Cons |
| Lower interest rates because of collateral | Can only be used for equipment |
| Helps businesses afford equipment | You may need a down payment |
| Tax benefits for equipment depreciation | If you stop paying, the lender can seize equipment |
Invoice Financing (Accounts Receivable Loans)
This type of loan involves borrowing money against unpaid customer invoices. It’s helpful in plugging the cash flow gaps created by slow-paying customers, and the loan can then be paid once customers pay their invoices.
| Pros | Cons |
| Quick access to capital | Fees and interest may be high |
| You don’t need personal collateral | Lender may assume control of customer invoices |
| Best for businesses with long invoice cycles | Not best for businesses with few invoices |
Merchant Cash Advances
This loan comes as a lump sum and is repaid through a percentage of daily credit card sales. It’s fast capital upfront, which is paid off over time by the business’ card sales, but this type of fast funding can also come with high fees and interest rates.
| Pros | Cons |
| Quick approval | Very high fees and interest |
| No fixed payments | Daily deductions can harm cash flow |
| Best for businesses with high card sales | Can lead to cycles of debt |
Commercial Real Estate Loans
Commercial real estate loans are for buying, renovating or refinancing business properties. They can also be structured in different ways: as traditional mortgages or SBA 504 loans. These loans are best for businesses where a brick-and-mortar presence is essential and the owner is prepared for a long-term payment plan.
| Pros | Cons |
| Can help build business assets | You need a large down payment |
| Lower rates than unsecured loans | Long-term commitment |
| Tax advantages to business property ownership | You risk property devaluation |
Microloans
As the name suggests, these are small loans — usually under $50,000 — designed for small businesses and startups. They’re typically offered by nonprofits, government programs and alternative lenders, and are best for small businesses looking to get on their feet.
| Pros | Cons |
| Great for startups, small businesses | Small loan amounts |
| Easier to qualify for than other loans | Rates can be higher than banks |
| Can help build business credit | Some can require extensive paperwork |
Franchise Loans
Franchise loans help entrepreneurs finance a franchise business, like a McDonald’s or Subway location. The loan money can be used for franchise fees, equipment and initial setup costs.
| Pros | Cons |
| Made for franchise-specific costs | Must follow franchise rules and costs |
| Can assist with startup costs | Some franchises can have high entry fees |
| Often available through franchisors | Approval might be difficult for new business owners |
Working Capital Loans
These loans cover short-term operational expenses such as payroll, rent and inventory. They come with high interest rates and are meant to pay for immediate needs rather than long-term investments.
| Pros | Cons |
| Quick funding for immediate needs | Higher interest rates |
| No long-term commitment | Not best for large purchases |
| Flexible use for operational costs | You often need good business credit |
Pros and Cons of Business Loans
Like any debt, business loans have pros and cons and the decision to take one should be made carefully.
| Pros | Cons |
| Help businesses grow | Interest and fees add to overall business costs |
| Provide working capital | Some loans require collateral |
| Build business credit over time | Approval can be difficult for startups/owners without good credit |
| Loan options can be flexible | High-risk loans can have very high rates |
How To Choose the Right Business Loan
Right off the bat, it should be clear that there are some business loan options off the table for you. For example, if you run an online business you won’t need a commercial real estate loan. If you run a startup, you often have fewer loan options available to you which narrows your search to microloans/SBA microloans.
Identify which loan options could be a fit for your business. This is based on your business type and your business needs, which can range from equipment to expansion to working capital and more. Then, compare loan terms, interest rates and repayment schedules for the loans you’re interested in.
Once you decide on a business loan type, check your credit score and business financials to make sure all is in order before applying. You should also consider whether collateral will be required and if so, how you can meet that requirement.
Where To Get a Business Loan
Business loans are typically offered by financial institutions, governments and some alternative sources like nonprofits. These include:
- Traditional banks: Ideal for established businesses with good credit
- Credit unions: Ideal for better rates and flexible terms
- Online lenders: Ideal for alternative funding options and quick approval
- SBA loans: Ideal for those who qualify and want government-backed financing with lower interest rates
Which Business Loan Is Right for You?
Your choice in business loan is a highly personal one that will depend upon a range of factors, including your business type, needs, credit, financial situation and much more. When making the choice for how to grow and fund your business through a loan, consider all the different loan types, repayment terms and lender options before applying.
FAQ About Types of Business Loans
- Which business loan has the lowest interest rate?
- SBA loans typically have lower interest rates because they're backed by the government, but they can be hard to qualify for. Equipment loans are also known to have lower rates since they're backed by collateral. Your loan rate will depend on individual factors as well, such as your business credit profile.
- Can I get a business loan with bad credit?
- Any type of loan will be much harder to secure with poor credit. However, options like merchant cash advances, invoice factoring and equipment financing may be easier to get approved for since they either don't depend on monthly payments or are backed by collateral.
- How long does it take to get a business loan?
- It depends on the type of business loan and lender you apply with. It can be a process that takes days or months.
- Are there business loans specifically for startups?
- Yes -- SBA microloans and other microloans are smaller loans ($50,000 or less) designed for startups and small businesses.
