How Does Business Loan Repayment Work?
After you’ve found a lender, gone through the application process, and received your funds, all you have left to do is spend your funds!
Oh yes, and repay your loan.
Unfortunately, as you are probably aware, loans are not free money. You have to pay them back. With interest.
Here’s everything you need to know to understand your terms of repayment, best practices for repaying your loan, and what you should do when you’re done paying your loan.
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How Small Business Loan Repayment Works
To repay your loan in a timely manner, it’s important to know whether or not your payments are fixed or variable, how often you have to repay, and how repayments are made. Let’s break down all the elements below.
When You Start Repaying
In the vast majority of cases, you’ll be expected to start repaying your business loan “immediately.” What immediately means depends on how often you’re supposed to make a payment (see below). If you have monthly payments, your payment cycle will probably begin around 30 days from when you receive your funds. If it’s weekly, the following week, etc.
There are exceptions, however. Certain lines of credit, for example, may not expect repayment until after the draw window has closed. Other loans may offer a period in which payment is deferred. For example, the SBA may defer payments on outstanding loans during an economic disaster like the one caused by COVID-19.
How You Make Payments
Gone are the days when you have to remember to write and mail in a check (mostly). Now, most lenders opt for an automatic repayment system, in which your payments are deducted right out of your bank account via ACH. All you have to do is make sure the money is in the proper bank account.
Some still allow payment via checks. However, many charge a check processing fee, which can cost your business a significant cost of money over time.
How Often You Repay
In the past, almost all loans were paid on a monthly basis. These days, lenders may require payments in many different intervals, including monthly, bi-monthly, weekly, or daily. Daily repayments are generally only made every weekday, excluding bank holidays.
Fixed vs. Variable Payments
Repayments may be fixed or variable.
Borrowers with a fixed repayment pay the same amount every time they make a payment. For example, a borrower might have to pay $341 on a bi-weekly basis until the loan is paid off. Barring extraneous circumstances, the borrower will never pay more or less than the $341 dollars.
Variable repayments mean the amount you’re paying may change. You may have a variable repayment schedule for one of two reasons:
You have a loan (or advance) that is repaid by deducting a percentage of your cash flow. For example, your lender might deduct 15% of each sale until the debt is repaid. These loans do not have a maturity date, because repayment is dependent upon your cash flow.
- Your interest rate is dependent upon the prime rate. If the prime rate goes up, so will your interest rate and consequently your payments. Naturally, if the interest rate drops, your interest rate and payments will as well. The prime rate is generally utilized by lenders who offer loans with long term lengths, or those that offer lines of credit.
How Long You Repay
Most loans come with a set schedule of payments that, collectively, is called your term length. This period may span from several months to over a decade. However, most installment loans do give you the option to overpay on each payment or pay the loan off early. In this case, your loan may end up not lasting as long as the term initially stated and will likely cost you less money over time.
Less common are income-contingent repayment plans, where your monthly payment is a percentage of your revenue stream. Since this can fluctuate depending on your income, the amount of time required to pay off your loan may not be hard and fast. If you’re doing great business, it’ll be shorter. If you’re struggling, it will be longer.
Repaying Your Business Loan: Best Practices
In theory, repaying your loan is easy; all you have to do is make your payments on time. However, poor budgeting or other hangups can make that concept a little more difficult. Here are a few tips to keep you on track.
Make a Budget
Whether you have to pay by check or your payments are deducted via ACH, you have to be sure the money is in the bank when you need it. To ensure the money is always there, it’s best to make a budget—or adjust your budget if you already have one.
According to Inc’s “How to Start a Business Budget,”
A budget should include your revenues, your costs, and — most importantly – your profits or cash flow so that you can figure out whether you have any money left over for capital improvements or capital expenses.
By keeping track of where your money is coming from and going to, and how much you’ll need for each month, you’ll be able to make sure you always have enough money to pay for everything necessary, business loans included.
For more information about how to make a budget, head over to Inc’s full article.
Know Your Lender’s Late Payment Policy
Due to unforeseen circumstances, you may not be able to make your payments. Lenders understand that, from time to time, problems may arise; many have a late payment policy for that reason.
For example, some lenders offer a short grace period, in which no fees will be charged and nothing will be reported to the credit agency. Others allow you to miss a certain amount of payments, which will then be added to the end of your repayment schedule.
Make sure you know your lender’s late payment policy, so you can make adjustments and get back on track while accruing a minimal amount of late fees and credit score hits.
Communicate With Your Lender
Lenders don’t like to be left in the dark; if your payments become irregular or stop, and they don’t hear from you, they’ll eventually assume that you’ve defaulted.
If you’re having problems making payments, call up your lender and let them know what’s going on ASAP. Often, lenders are willing to work out an alternative payment schedule, assuming you communicate quickly enough and don’t make a habit of irregular payments.
What To Do If You Can’t Repay
You’ll hear the term “risk” come up in the context of loans fairly often and with good reason: loans are risky for both the lender and the borrower. You can’t foresee every possible pitfall coming your way, and even cautious companies may find themselves unable to pay their loans.
There’s actually quite a lot you can do when you’re in danger of defaulting, from refinancing to negotiating with your lender. The important thing is that you should be proactive; you don’t want your loan to slip into default status without making a good faith attempt to resolve the situation.
When You Should Refinance
There comes a time when every business should consider refinancing its debt. (That is, taking out a new loan to pay off outstanding debt.)
There are two big reasons for refinancing:
- Your business has grown and you now have access to larger loans at lower costs. This is often referred to as “graduating” to better debt.
- You are struggling to repay your debt, so you need a loan with longer term lengths, smaller monthly payments, or less expensive interest rates and fees.
If either of those sounds like a situation you’re in, or one you may be in someday, read this guide to debt refinancing.
What To Do After You’ve Repaid Your Loan
Making your final payment on a loan, whenever that may be, is cause for celebration. Before you pull out the champagne, however, be aware that there are two things you still need to do.
First, make sure that automatic repayments have stopped. Automated repayment systems occasionally keep pulling payments, even if you’ve finished paying your debt. This can easily be remedied by calling up your lender and bringing the problem to their attention.
Second, check UCC records to ensure your lender has released any liens on your business. Liens left on your business will make it more difficult for you to find financing in the future. This article contains more information on UCC blanket liens.
Final Thoughts On Business Loan Repayment
Repayment can be the easiest or most difficult part of the lending process. A well-applied loan can help your business prosper. On the other hand, missing payments or defaulting on a loan can create problems for your business.
Learn to spot problems early on, and you’ll be able to solve repayment problems before they get started.
Ready for a loan? Check out our best lenders for small businesses.