The coronavirus pandemic impacted the world as a whole and the financing industry was deeply affected as well. One of the consequences of the global economic crisis is that banks have reduced loan origination and are raising their lending standards. This means that small and micro-business owners as well as sole traders have almost no chance to get traditional financing. Therefore, they have to try applying for alternative personal and small business loans or get credit cards. The question is which of these methods is the most efficient?
Alternative online financing usually comes with higher interest rates and more restrictions. Those are necessary to mitigate risks for lenders that take on poor-credit and other high-risk clients. At the moment, due to the COVID-19 crisis, many online lenders are on a brink of collapse. Therefore, they often make loan terms even more unfavorable.
Taking on this kind of debt can be a disaster for a small business. That’s why it’s imperative to consider the pros and cons of every loan type with extreme care.
Understanding Personal Loans: Pros, Cons, and Types
Personal loans are designed to help individuals through a financial crunch. They are mostly used to tide one over until they get payment from work or other sources. They are also sometimes used to pay for special needs, like hospital bills, weddings, or even vacations.
This type of loan is most often short-term and unsecured to ensure that the individual can get the money fast. Due to this, they have high interest rates, inflexible repayment terms, and a limited maximum loan amount.
The most common types of personal loans are:
- Unsecured loans.
These are the most common and straightforward type of personal loan. They can be used for anything and they require no collateral. However, usually they consider the borrower’s credit rating and require proof of employment. These loans have a higher-than-average APR. The rates can range from 5% to 40% and beyond. In most cases, the maximum loan term is 1-5 years. - Secured loans.
Secured personal loans use collateral, so they both have a higher limit and longer repayment term. They also have a lower interest rate. The majority of these loans revolve around borrowing against a car, personal savings, or any big asset. A much smaller version of this financing is offered by pawnshops. However, those outright prey on clients with very unfavorable rates. - Debt consolidation loans.
Debt consolidation can be a very good solution if you have multiple loans already and want to make use of the lower interest rates or other favorable circumstances. If nothing else, they often make large debt easier to manage. These loans often have a lower APR and very flexible terms. However, they might not be easy to obtain. - Co-sign loans.
These are the solution for those with really poor credit and no collateral. To take this loan you’ll need a co-signer who will act as your “security” for the lender. They are risky and hard to get.
Note that personal loans, and other types of financing, can have fixed or variable rates. This means that your regular payments will either be fixed for the duration of the loan or change with time. There is no saying which option is better as it will depend on the global economic circumstances. For example, due to the global recession banks are now dropping interest rates. However, the situation is often the opposite, so interest rates might grow between payments.
Types of Small Business Loans: Benefits and Limitations
Small business loans usually use some type of business’ assets or even future revenue as security. Therefore, they have better terms and lower interest rates. However, they might also have some highly specific eligibility requirements. For example, the age of the business and average revenue for the last 6-12 months are usually taken into account.
Common small business loan types are:
- Terms loans.
These are just like regular loans where you borrow a lump sum and pay it out over time. They are convenient and flexible and a good choice for business expansion. However, these loans usually require collateral and they will be more expensive from online lenders compared to banks. - Business lines of credit.
This is an unsecured and flexible type of loan similar to a credit card. Note that lines of credit often include additional costs. This type of financing is only available to strong businesses with a high credit score. - Equipment loans.
This type of loan uses business equipment you want to buy as collateral. The amount you can borrow is limited and dependent on the value of the equipment and its expected lifespan. Rates are also affected by those factors. This loan may require a down payment. Also, keep in mind that you take out a loan for a long time. However, your equipment can become outdated faster. With this type of financing, you might not be able to replace it effectively. However, if you succeed in repaying it, you will own the equipment outright. - Invoice factoring.
You can use this type of financing only if your business has unpaid customer invoices. The financing is mostly risk-free. However, you are losing a part of your expected revenue because you borrow the money. Invoice factoring brings quick cash easily. However, the portion of the profit you lose is significant considering the cost of this loan. - Invoice financing.
While similar, this type of loan doesn’t cost you quite as much. That’s because when using invoice financing you don’t actually sell your invoices. Instead, you use them as collateral to borrow money. Again, the amount will be limited. Also, you will be the one responsible to collect the payment. Therefore, you will have to deal with the consequences if the customer doesn’t pay. - Merchant cash advance.
Merchant cash advances are another type of quick unsecured business financing. Unlike with term loans, you make payments on this loan by withholding some percentage of your daily (or weekly, etc.) sales. The terms can vary, but the cost will usually be quite high overall.
When taking a business loan remember that the online financing industry is not well-regulated. You will have to double-check the lender’s certifications and licenses to make sure that your business can use its services legally.
Many Uses of Credit Card Financing
Credit cards are a good financing solution that people and businesses can use in a variety of situations. There are many types of these cards and they each offer some unique benefits. Credit cards are most popular with the millennials, but everyone else is using them as well. In fact, more and more business owners are beginning to appreciate the convenience of this financing.
However, while convenient, credit cards have too high interest rates for long-term uses. They are good for financing running expenses or building a better credit score.
There are personal and business credit cards. They mostly differ by reporting policies and credit limits. Bonuses offered as perks to attract customers will also differ to fit either business’ needs or individuals. For example, business credit cards can offer cashback on some business-related purchases or bonus rewards on phone bills, online advertising, etc. Personal cards are more likely to offer cashback from popular chain stores, boutiques, and restaurants.
Bottom Line: What Type of Loan Should You Use?
The current crisis is hitting small businesses hard. A great number of them have already failed and more are expected to do so. The lack of cash flow is the main reason for this, so loans are vitally important for small businesses’ survival. Both personal and business loans can be very helpful in this situation. However, you should remember that personal financing usually has worse terms in regards to repayment and interest rates. Credit cards, while convenient, are not the most flexible or reliable financing. Therefore, the best solution for small businesses is to apply for loans designed for them specifically. Only consider turning to other options if this one isn’t available in your situation.
