What are the different types of business loans

9 Types of Business Loans

What is the most common type of business loan? ‘Business loan’ is a versatile term encompassing a wide array of financing possibilities. It spans from secured loans to invoice financing to working capital loans. Discover more about the diverse sources of funding that might align with your business requirements.

If you find your business in need of additional financial resources, a business loan is one potential solution. It’s important to note that there isn’t a single, universal type of business loan, since the funding requirements vary for each business.

While all business loans necessitate repayment with interest, the specific mechanisms can differ significantly. Continue reading to explore the different kinds of business loans that are available, their potential use cases, and whether any of them might be a suitable fit for your business

Unsecured business loans

These loans can also be referred to as ‘term loans’ since you borrow a lump sum and then repay it in fixed instalments over a predetermined period.

In the case of an unsecured business loan, you aren’t obligated to provide any form of collateral as security. Instead, lenders assess a variety of factors, including your overall business financial health and your business credit score, to determine whether they will extend a loan to you.

Due to the absence of collateral, unsecured loans often come with higher interest rates compared to secured loans.

It’s worth noting that even though these loans are unsecured, certain lenders may request a personal guarantee. In such instances, a company owner or director pledges to personally repay the loan if their business is unable to do so, assuming personal responsibility for the debt repayment

Secured business loans

Businesses have the option to utilise secured loans as a means to secure a lump sum of capital, which they can then repay with interest over a predetermined period.

In contrast to unsecured loans, secured loans necessitate businesses to provide collateral, typically in the form of a property, though other high-value assets such as equipment or vehicles could also be acceptable.

Secured loans are considered less risky for lenders because, in the event that a business defaults on the loan, the lender has the legal right to take possession of the collateral asset. Consequently, lenders often perceive applications for secured loans as lower risk compared to unsecured loans, as they have the added assurance that they can recoup their funds if necessary.

This enhanced security may also result in lenders offering larger loan amounts with extended repayment periods and more favorable interest rates

Short-term business loans

True to its name, a short-term business loan is specifically structured to be repaid over a briefer timeframe compared to a conventional business loan.

These loans are a suitable choice when your business is confronted with the need to address sudden expenses or immediate costs.

When opting for these loan types, your business typically faces a shorter repayment window, often spanning just a few months, or potentially up to two years. Consequently, it’s crucial for your business to be confident in its ability to fully repay the loan.

The application process for short-term business loans is generally swift, making them an attractive option for businesses in need of rapid financing. Nonetheless, it’s important to bear in mind that the interest rates on short-term business loans may be higher in comparison to those on longer-term loans

Working capital loans

Working capital loans serve as another form of short-term financing for businesses, with the primary purpose of bridging gaps in cash flow, ensuring the seamless operation of your business.

In the course of running your business, you may encounter situations where you lack the necessary funds in your account to meet essential financial obligations, such as paying bills or purchasing inventory. This scenario is particularly common for businesses with seasonal fluctuations in income. A working capital loan is specifically tailored to address these financial shortfalls.

It’s imperative to have a high degree of confidence that your business will generate the necessary funds in the future to enable the full and timely repayment of the loan.

Invoice financing

Invoice financing is a secured method of obtaining business funds, predicated on the total worth of your unpaid invoices.

Rather than waiting for a customer to settle an outstanding invoice, if you require prompt access to cash, you have the option to transfer the invoice to a lending institution. Subsequently, the lender extends a loan, typically amounting to a percentage of the invoice’s value, which you will repay at a later date. Typically, you can obtain between 70% and 90% of the invoice’s value.

The extent of the loan you can secure through invoice financing is contingent on the collective value of your unpaid invoices. This financial approach can be executed in slightly different manners, contingent on whether you opt for invoice factoring or invoice discounting.

Invoice factoring involves the lender taking control of the invoice, resulting in the customer owing payment directly to the lender. It is the lender’s responsibility to pursue and collect the payment.

Conversely, with invoice discounting, you maintain control over your invoices, and your customers remain unaware of your use of this credit facility, as they continue to remit payment directly to you. In this scenario, you will subsequently repay the lender in accordance with the predetermined terms of your agreement.

COMPARE: Invoice financing provider

Asset financing

Asset finance serves as another category of secured borrowing, with the collateral typically being assets such as equipment or machinery. This arrangement enables businesses to acquire necessary tools and assets, even if purchasing them outright isn’t financially feasible.

Asset finance can be structured in various ways. For instance, it may take the form of a lease agreement, where you make monthly payments to utilize a specific piece of equipment for a predetermined period, after which you return the item.

Alternatively, you might have the option to spread the cost of an asset over a fixed duration, and upon completing all the scheduled payments, you gain full ownership of the asset.

In cases where you already possess a high-value asset and require access to capital, asset refinancing emerges as a potential solution. In this scenario, a lender extends a loan equivalent to a certain percentage of the asset’s value, which you subsequently repay.

MORE: Asset finance explained

Credit lines

A credit line, often referred to as a line of credit, represents a highly adaptable financing option for businesses. Instead of applying for a fixed sum of money, a credit line permits you to borrow as much or as little as required.

This financial instrument operates much like a credit card, where the lender establishes a predefined credit limit. Once this limit is approved, you have the freedom to borrow funds up to this limit whenever the need arises. Importantly, you’re only charged interest on the amount you actually utilize, not on the entire credit limit, and the repayment terms are typically more flexible compared to traditional term loans.

Certain credit lines are ‘revolving,’ which means that once you repay what you owe, you can access the entire credit limit once again, provided you adhere to the terms of the agreement.

The flexibility inherent in this form of financing can be especially advantageous for businesses uncertain about their future borrowing needs. It ensures that you only borrow and accrue interest on the precise amount of money you require. Credit lines can be secured or unsecured, offering businesses various options to suit their specific circumstances.

Merchant cash advance

A merchant cash advance represents an alternative method for businesses to secure a lump sum of capital. However, unlike traditional loans with fixed monthly installments, repayment is tied to card transactions.

Consequently, this option is best suited for businesses that handle a significant volume of card transactions.

When a customer conducts a card transaction through your terminal, a portion of that transaction is automatically allocated to repay the cash advance. Collaboration between the lender and the card terminal provider facilitates this process.

Unlike a typical business loan, merchant cash advances do not require a fixed monthly repayment. Repayments are solely drawn from card transactions, meaning that the faster your business generates income, the quicker you’ll pay off the advance.

The amount you can borrow through a merchant cash advance hinges on several factors, including the monthly revenue your business garners from card transactions. Since the availability of merchant cash advances is primarily linked to your business’s income, the borrowing limits may be lower compared to other loan types.

Government loans

National and regional government-backed business loans are instrumental in fostering business development and growth.

One illustration of such government support is the Start Up Loans scheme. This initiative enables businesses that have been in operation for less than three years, provided they meet the specified eligibility criteria, to secure loans ranging from £500 to £25,000. In addition to loan access, businesses approved under this scheme can benefit from valuable free advice and mentoring.

Furthermore, it’s advisable to explore potential eligibility for local or national grants. Business grants serve as a valuable means of securing funding, and the notable distinction from business loans is that grants do not necessitate repayment.

Business Marketing Specialist at PDQ Funding | + posts

Jarred Musson is a versatile writer with a diverse educational background and a passion for all things business. Holding a Master of Science (MSc) degree in Marketing and a Bachelor of Arts (BA Hons) in Multimedia Journalism from Manchester Metropolitan University, Jarred possesses a unique blend of expertise that allows him to dissect and communicate complex business topics with clarity and precision.