Over the past several years, online loans for small businesses have become more and more popular. It’s no surprise why: these business loans are easy to apply for and usually promise quick funding. Not all online loans are the same, and there are a few red flags you should watch for before you apply.
What are online loans for small businesses, and how much will they cost you in the long run? Let’s find out!
What are online loans for small businesses?
Simply put, online loans are business loans that you can apply for through an online digital portal. Many online lenders will offer a virtual closing process as well. It’s also common for online lenders to promise funding much quicker than traditional lenders can.
In this article, you’ll learn about short-term online business loans, which must be repaid in one year or less. Many reputable lenders offer longer-term loans through online portals at affordable prices too.
When did the online lending trend start? It really began during the financial crisis of 2008. This was when alternatives to traditional small business loans, including online lending, started to grow. Online business loans are now a multi-billion dollar industry but are still mostly unregulated by the federal government.
The online application process is pretty straightforward and focuses on these key items:
- Time in business (minimum of at least one year in operation on average)
- The average daily cash balance in your bank account
- Revenues (minimum annual revenue of $50,000 to $100,000)
- Personal credit score (minimum credit score of 500 to 550)
Your typical online lender will evaluate these criteria to quickly approve loans, using financial technology to calculate risk. It usually takes less than one business day for an online lender to approve your application once it’s completed.
There are a few different kinds of short-term online loans, including:
- Invoice factoring: selling your invoices to a factoring company at a discount for quick capital
- Merchant cash advance: borrowing an amount of money that’s repaid using a portion of your debit and credit card revenues (plus fees)
- Term loans with repayment terms of one year or less: a typical business loan but likely with a higher interest rate and rapid repayment requirements
Online lenders generally base your loan approval amount on the size of your revenues. For example, if you have $200,000 in revenues, you might get approved for 15%, which would be $30,000.
Some online lenders will determine the amount you must pay back using a factor rate. The factor rate is different from an interest rate because it’s based on your original loan amount, not the amount you have left to repay. If you receive a cash advance of $30,000 at a 1.3-factor rate, then you would owe back $39,000. Repayment terms vary, but there are some online loans for small businesses that require daily or weekly repayment.
Most lenders also charge an origination fee based on your loan amount. This fee is usually deducted from the loan amount upfront. Personal guarantees are part of the standard requirements too. This is your personal promise to repay the loan in case your business is unable to repay it.
If you’re considering applying for an online loan, ask some questions first. Find out how often payments are required and what fees are included in the loan. A reputable lender will be upfront about what’s required as part of your loan. If the lender won’t answer these questions or won’t give specifics, that’s a red flag. You’ll want to find a more responsible lender for your financing.
Why use online loans for small businesses?
There are many reasons why you might apply for an online business loan. Perhaps you’ve applied for a loan at a bank but didn’t qualify, or you haven’t been in business long enough to be eligible. Many business owners apply for online loans when they need financing immediately. An online lender is willing to take on more repayment risk in exchange for a higher interest rate.
This is important to remember: the tradeoff for the convenience and speed of an online loan can be its high actual cost. When researching online loans, consider the payback amount, fees, and repayment schedule.
How do I calculate the actual cost of an online business loan?
One piece of information you’ll want to find during your research is the online lender’s annual percentage rate (APR). If a lender doesn’t make this public or won’t answer this question when you ask, that’s another red flag. To calculate the APR and actual cost of the online loan, you need to have the following information:
Factor rate: The multiple of the cash advance you’ll need to pay over the specified period.
Example: $30,000 loan amount x 1.3 factor rate = $39,000 payback amount
Origination fee: The percentage of the loan amount you’re charged to process the loan.
Example: $30,000 loan x 2.5% = $750 origination fee
Repayment term: How frequently you’ll need to make payments.
Example: Number of repayment days per month x 9-month term = 270 days
Using this information with a loan calculator, you can learn the actual cost of an online loan. In this example, your annual interest rate appears to be 30% based on the factor rate of 1.3. However, when you consider that you’re making daily repayments, the calculated APR is significantly higher at 58.4%! Given the high APR, the typical short-term online loan is not usually the best financing option.
What are the alternatives to online loans for small businesses?
If you need working capital but don’t qualify for traditional bank financing, you might be eligible for funding from community lenders.
One type of lender in this category is Community Development Financial Institutions (CDFIs). CDFIs are primarily non-profit organizations with access to lower-cost community and economic development loan funds. This helps them provide smaller loans to business owners who do not meet conventional banking criteria.
Many CDFIs offer business loans through an online application, making it even easier to get the funding you need. You’ll find that the APR on CDFI loans are significantly lower than a short-term lender because they’re committed to offering affordable and responsible financing.
Pursuit can support your working capital needs
If you need working capital, avoid the high cost of short-term online loans and apply with Pursuit! You can explore more than 15 financing options for nearly any business need. Get started on your application today and contact us for help!