Deal or no deal? How to evaluate a business loan offer?

There are countless situations when taking out a small business loan makes perfect sense. For instance, when you need a cash infusion to expand your business, purchase high-value assets, hire more workers, or get into a new venture. If your business is creditworthy (has a good credit score, strong cash flow, solid business plan, the necessary collateral, etc.), you'll have no problem getting loan offers from various lenders.

Now the big question is, how do you determine the best loan offer? You can’t just pick a loan deal out of a hat. Not with so many factors to consider when evaluating a loan’s suitability. And remember that the wrong loan might not serve the intended purpose and could even weaken your cash flow and financial health.

So how do you tell the good loans from the bad? This article is about deciding if a loan offer is right for you. Read on and find out:

Start with a loan evaluation template

Before evaluating any loans, ensure you’ve worked out exactly what you need down to the last detail. Interestingly, evaluating a loan has more to do with your business and the purpose for the loan than the offer itself. So, what does an ideal loan product for your business look like? Here are seven important questions you should ask yourself before applying for a business loan:

1. What do I need the money for, and is borrowing the best way to go?
2. How much money do I need to meet my needs?
3. What amount can I afford to pay back every month?
4. How quickly can I pay off the loan?
5. How soon do I need the money?
6. How exactly will the loan benefit my business?
7. What’s the maximum cost (interest and fees) that will still justify the loan’s value?

The answers to these questions will help you develop a checklist to qualify offers. The idea is to find the product that most closely matches your ideal loan. An exact match may not be possible since your template will probably be too biased. But be careful not to make compromises that defeat the loan’s purpose or value.

Key considerations when evaluating an SMB loan offer

Let’s look at the crucial loan details, characteristics, and terms you should pay attention to when choosing a small business loan.

1. The fine-print terms

There’s more to a loan’s terms than the all too obvious qualifying requirements, rates, and repayment plans. The lender may also embed some intricate limitations and technicalities in the loan agreement's fine print under heavy jargon or ambiguity.

Be sure to review the loan contract closely (along with an attorney or professional accountant if necessary). And do not hesitate to ask the lender to clarify any clauses you don’t understand. As you do so, watch out for these key items:

• Extra contingencies for getting the loan
• The disbursement procedures
• The nature of the repayment transactions
• The creditor’s definitions of late, early, and default payments
• Repercussions for non-payment or other breaches of contract
• The loan’s governing law (usually under state legislation)
• Insurance coverage on the loan
• Additional fees
• Reimbursement terms for overpayment
• Other borrower responsibilities in servicing the loan besides repayment

Lenders rarely advertise such details openly. And while such terms may not necessarily be unfair to you as the borrower, they can greatly impact the loan's overall structure and your relationship with the lender during the loan’s term. So, ensure you understand the contract clearly in its entirety and agree with all the conditions within before signing on the dotted line.

2. Rates, fees, and total cost

How much is the loan going to cost? The interest rate forms the bulk of a loan’s cost. But interest is not the only cost factor. Most business loans come with extra fees that really add up to the total cost. Even the interest rate isn’t always that straightforward.

Most business term loans are amortized with the interest rate given as the Annual Percentage Rate (APR). The APR represents the total annual cost of the loan (interest + fees) expressed as a percentage of the payable principal. A fully amortized loan has equal monthly payments or installments split between the principal and the interest. Meanwhile, partially amortized loans combine installment and balloon payments.

The figure below shows the formula for calculating the total repayment of an amortized business loan using its APR:

Alternatively, you can use our online loan calculator to get instant results without doing any of the tedious math.

The federal Truth-in-Lending Act requires that lenders disclose to borrowers the APR, financing fees, and the sum of total payments to be made on any loan. However, the lender is not obligated to include all the financing fees in the APR. So, check the contract or ask the lender if there are additional fees such as upfront out-of-pocket, origination, insurance, or transaction charges that you should know about. Then add those up (if any) to get the loan's actual cost.

3. The loan’s ROI

One of the main reasons for calculating the total cost of a loan is to work out its ROI (return on investment). ROI measures an investment's profitability relative to its cost. In the case of a loan, profit means the financial value of purchases or investments made using the loan minus its cost. For instance, if you plan to use the loan to purchase business equipment, the loan's gross profit will be whatever monetary benefits result from that purchase, either as cost savings or an increase in revenue.

This is how you calculate a loan’s ROI:

Generally, anything above 5% is considered a good annual ROI. This is an important metric to justify the need for a loan and determine cost fairness against returns.

4. The loan’s timelines

Timing is critical when applying for and utilizing a business loan. Depending on when and why you need the loan, it's important to understand the intricate timeframes in order to plan accordingly. Here’s a list of common loan timelines that have a huge impact on the closing and repayment schedules:

• Application time – How long it takes to apply for a loan.
• Application window – Some loans are only available to borrowers within a specific time window.
• Approval time – How long the lender takes to approve (or deny) a loan proposal.
• Disbursement time – The time gap between approval and funding.
• Grace period – A period in which you don’t have to make loan payments, usually the first few months after the loan is disbursed.
• Loan term – The total number of months or years you’ll have to repay the loan.
• Loan period – The shortest time between payments or interest calculations.
• Due date – The specific day your payment is due in each cycle.

5. Competing offers

One of the best ways to determine a loan's competitiveness is by pitting it against similar offers from other lenders. Shop around to benchmark favorable loan terms before settling on an offer. You might just be surprised at the immense differences between seemingly identical loan products. Plus, each lender has a unique set of qualification and approval requirements that ultimately determine the loan’s structure for each borrower.

Researching lenders is a critical stage in evaluating loans. But it can be tedious, time-consuming, and discouraging work. Just picture jumping from lender to lender asking about their loan offers, which in most cases involves filling out pre-qualification forms and waiting for a response. Imagine doing that with dozens of lenders — it's just too wasteful.

Surely, there must be a better way to hunt for business-friendly loans. And there is. Lendzero does all the research and pre-qualifying processes for you, matching your business with potential lenders and financing solutions in a matter of minutes. You don’t even have to haggle with lenders because we take care of that too. Yet all this convenience and speed comes at zero cost to you. Start with Lendzero today and explore the financing world like never before.