Getting a loan to expand your small business can be a great strategic move. However, the entire process can become quite complicated if you’re not aware of the jargon used in loan applications. Many apply for small business loans to carry out their expansion plans or grow their business. However, when reading the fine print of their financing contract, they seem to get overwhelmed with the technical language used by finance providers.
Don’t worry if you feel confused about the various terminologies in the financing contract. We’ll discuss some common loan terminologies that’ll help you better understand your financing contract.
Annual percentage rate or APR is one of the most used loan terminologies that you’ll come across. It indicates the yearly cost of taking out the loan. The APR includes the interest rate and other finance charges included in the loan agreement. For example, you might need to pay a loan origination fee when you take out a mortgage or a commercial loan. If you only look at the interest rate, it will be lower than the APR as it doesn’t include the origination fee.
APR helps you understand the actual cost of the loan. Lenders are required by law to disclose the APR that helps businesses make the right decision as they would better understand the total cost of the loan.
Defaulting on a loan or borrower default occurs when the borrower doesn’t repay the obligation within the stipulated timeframe and as per the agreement in the loan contract. If your business is a little late on loan, your lender might work with you.
However, if you don’t respond to timely reminders about loan repayments and are overdue for months, they may send your loan to an external debt collector. These debt collectors can report your nonpayment to the credit bureaus, which will significantly affect your credit score.
When someone partners with you to get a loan and is jointly responsible for the repayments, they are called co-borrowers. If you and your business partner take out a personal loan, then you’d both be co-borrowers. Lenders use the information for both parties to verify their ability to get the loan. If approved, both names will appear on the loan agreement, and they’ll share ownership of the asset being sought according to pre-defined limits.
Another term frequently used in loan agreements and applications is the credit score. Lenders will check your credit score before approving any loan. Your FICO credit score will range from 300 to 850, with 850 the best. Your credit score is based on several factors, including payment history, current debt, length of credit history, the mix of credit, and any new credit activity undertaken. The best loan terms are reserved for people with a high credit score. 670 is considered to be a good credit score.
Hard Credit Check
Credit checks are usually performed by lenders when you apply for a loan. The lenders undergo a hard credit check or inquiry which has a minor impact on your credit score. These hard credit checks remain on your report for two years, so make sure you only apply for a loan when you’re 100% certain you need it to avoid multiple hard credit checks that can significantly reduce your score.
Lenders consider various factors before deciding to approve your loan request. Amongst the first things they look at is your gross business income. This is the total money you’ve earned before taxes, and other deductions are accounted for. Lenders use the gross income to calculate your debt-to-income ratio, which is another crucial factor determining your loan application’s success. The ratio compares your monthly income with the total debt you currently have.
Once you’re successful in your loan application, your lender will provide you with various documentation regarding your loan. Among them would be your loan agreement, a legal contract between you and your lender. The document has essential information about your total repayment amount, including principal and interest. The APR applied on loan and any late surcharge applicable in case the borrower is late on their repayments.
The loan agreement will also contain your payment schedule and how you can repay your loan obligation. Also, you’d find information on the procedures and actions the lender can take if you default on your loan. Make sure to thoroughly read the document to understand every aspect of your loan.
The loan limit is the maximum amount of money the lender can give you. It is not necessary to draw out the maximum amount. You can choose an amount within your maximum limit. Your loan limit is calculated through various factors, including your income, credit score, and DTI. Always consider your ability to repay and budget before deciding upon a loan amount. It is unwise to take the maximum loan amount and then struggle to repay it.
The amount of money you’ve agreed with your lender to borrow is the principal amount. As you begin to pay your monthly payments, you’ll see your principal balance going down. However, keep in mind that the principal amount doesn’t include any interest payments.
Interest is known as the cost of borrowing the loan. Lenders will charge a percentage of the loan amount as a service fee for allowing you to borrow their money. Your minimum monthly payments will comprise the principal amount and the interest you owe. Gradually you start paying more towards your principal and less towards interest as your loan balance decreases.
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If you want to learn more about their services, visit their website. Alternatively, feel free to contact them for more information.