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Knowing when to go for a bank loan

Knowing when to go for a bank loan

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A loan is an amount of money borrowed for a set period within an agreed repayment schedule. And according to, the repayment amount will depend on the size and duration of the loan and the rate of interest.

Loans are generally most suitable for paying for assets – such as vehicles and computers, start-up capital and instances where the amount of money you need is not going to change.

The terms and price of loans vary among providers and will reflect the risk and cost to the bank in providing the finance. For larger sums, the pricing and terms may be negotiable.

Banks will loan money to businesses on the basis of an adequate return for their investment, to reflect the risks of defaulting and to cover administrative costs. If you have an established relationship with your bank, it would have developed a good understanding of your business. This will help it to advise you on the best product for your financial needs.

Bank loans are generally available to finance the purchase of inventory and equipment as well as to obtain operating capital and funds for business expansion.

These loans are a time-honoured and reliable method of financing a small business, but banks often finance firms with substantial collateral and a long track record, and the terms they offer are very strict.

Business owners should weigh the advantages and disadvantages of bank loans against other means of finance, according to

 Basic advantages of bank loans

A bank loans money to a business based on the value of the business and its perceived ability to service the loan by making payments on time and in full.

Banks do not take any ownership position in businesses. Bank personnel also do not get involved in any aspect of running a business to which a bank grants a loan. Once a business borrower has paid off a loan, there is no more obligation to or involvement with the bank lender unless the borrower wishes to take out a subsequent loan.

Tax and financial planning advantages

The interest on business bank loans is tax-deductible. In addition, especially with fixed-rate loans, in which the interest rate does not change during the course of a loan, loan servicing payments remain the same throughout the life of the loan. This makes it easy for businesses to budget and plan for monthly loan payments.

Even if the loan is an adjustable-rate loan, business owners can use a simple spreadsheet to compute future payments in the event of a change in rates.

Difficulties in obtaining loans

One of the greatest disadvantages of bank loans is that they are very difficult to obtain unless a small business has a substantial track record or valuable collateral such as real estate. Banks are careful to lend only to businesses that can clearly repay their loans, and they make sure that they are able to cover losses in the event of default. Business borrowers can be required to provide personal guarantees. This means the borrower’s personal assets can be seized if the business fails and is unable to repay all or part of the loan.

Cost of bank loans

Interest rates for small business loans from banks can be quite high, and the amount of bank funding for which a business qualifies is often not sufficient to completely meet its needs. The high interest rate for the funding a business does receive often stunts its expansion, because the business needs to not only service the loan but also deal with additional funding to cover funds not provided by the bank.

According to a report by, whether you are planning to start a business, buy inventory for an existing one or expand operations, you probably need a substantial amount of money. If you do not have the money lying around, you will need financing, and one of your financing options is to secure a bank loan.

These loans offer certain tax breaks and have lower interest rates compared to credit cards and overdrafts. However, you must meet a range of loan requirements, and the burden of repayment can wear you down.

Flexibility: With bank loans, you only need to worry about making your regular instalment payments on time. This is an advantage over overdrafts, where you must pay the full amount when the bank demands it.

In addition, banks do not usually monitor how you use your loan as long as you make your payments on time, so you can invest it how you deem fit.

Cost effective: In terms of interest rates, bank loans are usually the cheapest option versus overdrafts and credit cards.

Retained profits: While businesses that issue equity to raise capital often give a percentage of their profits to shareholders, banks require borrowers to pay only the principal and interest amount on a loan. As such, you will retain all your business profits.

Tax benefits: When you use a bank loan for business reasons, the interest you pay on the loan is a tax-deductible expense.

Strict requirements: Because many bank loans require some form of collateral, start-ups and existing businesses without any assets can find it difficult to get their loan applications approved. If these borrowers choose to go for unsecured loans, they are hit with higher interest rates.

Repayment burden: Loan borrowers must make periodic payments to their banks. Those who fall behind on payments face the prospect of having their assets seized. Even if you manage to make late payments, your bank could still report you to credit bureaus, a move that negatively affects your credit score.

With a lower score, obtaining loans in the future becomes more difficult. The repayment burden is a disadvantage compared to raising money through shareholders, because shareholders do not require regular repayments. Instead, they are typically paid dividends only on profits.

Irregular payment amount: If you get a bank loan with a variable interest rate, the rate changes with market conditions. This makes it difficult to determine the exact amount of future payments. Consequently, it becomes challenging to make sound financial plans.

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