When your business is ready for the next step, a small business loan can make it easy. However, a loan is more than just receiving money. Applications can be tedious, and the terms are highly confusing. In this lending glossary, you’ll learn all the common loan terminology so you can be better prepared when you apply.
General lending terminology
Here are the most important and common terms you’ll encounter during the general loan process:
Conventional lender
This is your traditional lender. Most often, there are banks.
Alternative lenders
Alternative lenders offer a wide variety of funding sources. These include community development financial institutions (CDFIs) and certified development companies (CDCs) that are non-profit lenders approved by the U.S. Small Business Administration (SBA) to offer their loan options. Many online lenders and some credit unions also fall into this category.
Criteria
Every lender will have specific requirements for you to qualify for their loans. Typically, this is a minimum credit score, proof of income, and business financials to determine if you’re a good fit for their products. Conventional lenders tend to have more strict criteria requirements, while alternative lenders can be more flexible.
Working capital
Working capital is the amount of money your business has available to fund the day-to-day operations after your current expenses.
Loan requirements
This is the information lenders need to consider when deciding on your loan application. For example, your business credit score, business plan, financial statements, and your cash flow.
Underwriting
This is the process that lenders go through to ensure your business can repay the proposed loan. During this process, lenders address your character, business and personal finances, credit score, experience, and many other factors to decide whether or not to approve your application.
Loan principal
Your loan principal is the money that’s borrowed before interest and any additional fees are added. The amount you pay toward your loan each month includes a portion of the loan principal and the interest on the loan.
Repayment period
A repayment period is the amount of time you’re given to pay back the principal, interest, and any fees for the loan. It makes a big difference in your monthly payments. For example, a $10,000 working capital loan with a five-year repayment period will be much easier for you to repay than the same loan with a repayment period of six months.
Collateral
Collateral is a tangible asset that’s used as security for loan repayment and is forfeited if you default.
Default
Defaulting on a loan happens when you haven’t paid back the amount you owe as you agreed to. If this happens, your lender can claim any collateral you pledged or take other steps to reduce losses. It’s a good idea to contact your lender if you’re having trouble making payments, and they’ll often work with you to negotiate temporary or long-term solutions.
Promissory note
This is your legal written promise to repay the borrowed money.
Balloon payment
A balloon payment is the unpaid remainder of the loan that’s due at the end of your repayment period. This occurs when a repayment schedule isn’t fully amortized over the loan’s lifetime, resulting in a large payment due at the end of your repayment period. The reason for this is to help give you a lower monthly payment over the course of the loan.
SBA lending terminology
The U.S. Small Business Administration (SBA) is the federal agency tasked with helping small business owners get easier access to funding. They have loan programs specifically designed with small businesses in mind, including the SBA 504 loan, the SBA 7(a) loan, and the SBA Microloan, which offer affordable interest rates and terms, and more flexible eligibility and approval criteria.
When you are considering an SBA loan, there’s some terminology specific to the SBA and their loan programs. Here are the ones you’ll encounter:
Small business
The SBA determines whether or not your business is classified as “small” by examining it in relation to its industry, staff size, and business revenue.
Third-party lender
This lender partners with the certified development company (CDC) to finance an SBA 504 loan. Typically, this third-party lender is a bank.
Eligible passive company (EPC)
If you create a separate real estate holding company for the property you purchased through an SBA 504 or SBA 7(a) loan, this will be referred to as your eligible passive company.
Eligible project costs
These are costs that can be financed with your SBA loan, like land acquisition, building purchase, construction and renovation, and equipment.
NAICS code
This is the acronym for the North American Industry Classification System. The NAICS code system classifies every business based on the type of industry they operate in, and the services and products offered. Lenders use this code to compare industry trends and data from other businesses within your same NAICS code. The SBA also specifically uses the NAICS code to determine affiliation.
Affiliate
In SBA terms, an affiliate typically means another business that you have a controlling interest in. With the new SBA rule changes, the two factors that determine affiliation are ownership percentage and the NAICS code.
Contracting assistance programs
Contracting assistance programs offer resources on federal contracting to help your small businesses.
Lending metrics
There are many measurements calculated for SBA and general loans that are important for you to know. Here are the most common ones you’ll see:
Interest rate
The interest rate on a loan is the amount that your lender charges you for borrowing funds. Interest rates for a loan can be fixed or variable:
- Fixed interest rate: A fixed interest rate is the same over the life of the loan, no matter what happens to interest rates outside of the loan. This is beneficial when rates are lower because you’ll lock in a lower rate until the loan is paid in full. If interest rates go down, then you may still be able to refinance your higher-rate loan to one with a lower rate.
- Variable interest rate: A variable interest rate changes throughout the life of the loan. Variable rates have a rate interval set by your lender to determine when the interest rates are recalculated. Common intervals are monthly, quarterly, or annually.
Annual percentage rate (APR)
The APR will give you the most accurate picture of the actual cost of your loan because it includes any fees that are rolled into the overall cost of the loan as well as the repayment time.
Monthly principal and interest (P&I) payments
This refers to the monthly principal and interest payments you must make during the life of your loan.
Interest-only period
Some loans carry an interest-only period where you only have to repay the interest, not the principal. The reason for this period is to ease your financial stress when a project includes the construction or renovation of a property, and your business will experience a significant delay before it can be operational.
Prime rate
This is the base interest rate used to calculate your loan’s interest rate, The Wall Street Journal prime rate is often used in the calculation. For example, the interest rate on an SBA 7(a) loan would be “Prime + 2.75%.”
Loan-to-value ratio (LTV)
LTV is a financial term that expresses the value of an asset compared to the loan needed for its purchase. For SBA 504 loans, the LTV typically consists of 50% from the third-party lender, 40% from the SBA-backed debenture, and 10% from you.
Debt service coverage ratio (DSCR)
The DSCR is a financial ratio that measures your business’s ability to serve its debt with its operating income. It’s calculated by dividing your net operating income by total debt service.
Equity injection
This is the amount of money you must contribute to a project and is often required as a down payment. For SBA 504 loans, this is typically 10% of the total project cost.
It’s important to understand these terms
Lenders have a whole set of vocabulary you might not have heard before, especially if this is your first time applying for a business loan. Use this glossary to guide you through the lending process and make sure you’re prepared!
Pursuit can help guide you through the business loan process
Pursuit can help you learn more about the loan process so you can move forward with confidence. In addition to resources like this lending glossary, we offer more than 15 loan options and a business line of credit and advisory services for small businesses in New York, New Jersey, Connecticut, Pennsylvania, Illinois, Nevada, and Washington.
Contact us today to learn how we can help you keep your business moving forward.
