40% of small businesses in the United States will get a loan at some point, according to a 2014 study by Harvard Business School. It’s a popular option when a small business needs cash, but getting a loan shouldn’t be taken lightly. Debt has a sneaky way of piling up. However, if you think loan is the right option, there some easy mistakes you can avoid, if you ask the right questions.
From an accountant’s perspective, here are 5 questions to ask yourself before obtaining a loan for your business
1. Do I really need this?
It sounds like a simple question, but it really isn’t. Do you really need this loan, or are you just trying to jump-start your business and avoid the patience required to steadily grow it? Is the money you seek a dire need, or just a “nice to have”? If restlessness is driving your decision, reconsider the loan.
We all want to see our businesses grow quickly, but borrowing money to get through slow times is dangerous practice. Even if you think you’ve made an accurate estimate of how much you’re going to earn in the future, your minimum payments on loans can sink that bottom line. Avoid debt when you can.
If you’re not in a dire need of a large immediate investment, consider putting aside each month the amount you’d pay for a loan. That savings will add up and you’ll avoid the cost and risk of a long-term loan.
2. How long will I be in debt?
The length of a loan is crucial. Generally speaking, the longer the loan, the more interest you’ll pay. Extend the terms of the loan long enough and you could end up paying thousands of dollars more in just interest! In addition, the collateral you offer on the loan will not be of use to you during that time (not to mention it’s up for being taken away if you default on the loan).
3. What other fees are involved?
The cost of the loan won’t just be the interest. Some of the fees that people don’t usually consider are:
- Application fees
- Credit evaluation
- Loan processing
- Appraisal of the collateral
- Prepayment penalties
If you do opt to borrow, try to negotiate those fees, or at least find the cheapest loan you can.
4. How should I tackle adjustable rates?
Long-term loans are usually divided into two parts: a fixed-rate period and an adjustable-rate period. For example, a 2/28 system is a 30-year loan where you’ll have a fixed-rate payment for the first two years, while the other 28 will be adjustable (this is sometimes called floating).
With adjustable rate, interest will be dependent market fluctuations and moves by the Fed. That leaves a lot of financial uncertainty for your business. If you do get a loan, aim for longer fixed-rate period, even if that means slightly higher interest, or shop for a loan that has a reasonable limit for the adjustable-rate interest.
5. Am I control of this decision?
The best advice I can give you is to stay informed, stay alert, and maintain your authority over the decision to obtain a loan. Don’t be intimidated by the loan officer or allow politeness to keep you in a situation that makes you uncomfortable. If you’re being pushed into borrowing more than you need, if you’re not given copies of all loan documents, if they are asking you to sign any blank documents, or asking you to do anything that makes your “antennae” stand up, walk away. Your sixth sense is often extremely perceptive in when it comes to signing loan docs. Listen to it.
Getting a loan is serious business, and small mistakes could set you back for years to come. Seek professional help where you need it, and rely on your good sense to see you through the process.
