A loan is an amount of money borrowed for a set period within an agreed repayment schedule. The repayment amount will depend on the size and duration of the loan and the rate of interest.
Loans are generally most suitable for:
- paying for assets - eg vehicles and computers
- start-up capital
- instances where the amount of money you need is not going to change
The terms and price of loans will vary between providers and will reflect the risk and cost to the bank in providing the finance. For larger sums, the pricing and terms may be negotiable.
Banks will loan money to businesses on the basis of an adequate return for their investment, to reflect the risks of defaulting and to cover administrative costs. If you have an established relationship with your bank, they will have developed a good understanding of your business. This will help them to advise you about the best product for your financial needs.
Different types of bank loan include:
- working capital loans - for short notice or emergency situations
- fixed asset loans - for buying assets where the asset itself is collateral
- factoring loans - loans based on money owed to your business by customers
- hire purchase loans - for long-term purchase of assets such as vehicles or machinery
Advantages of term loans
- The loan is not repayable on demand and so available for the term of the loan - generally three to ten years - unless you breach the loan conditions.
- Loans can be tied to the lifetime of the equipment or other assets you're borrowing the money to pay for.
- At the beginning of the term of the loan you may be able to negotiate a repayment holiday, meaning that you only pay interest for a certain amount of time while repayments on the capital are frozen.
- While you must pay interest on your loan, you do not have to give the lender a percentage of your profits or a share in your company.
- Interest rates may be fixed for the term so you will know the level of repayments throughout the life of the loan.
- There may be an arrangement fee that is paid at the start of the loan but not throughout its life. If it is an on-demand loan, an annual renewal fee may be payable.
Disadvantages of loans
- Larger loans will have certain terms and conditions or covenants that you must adhere to, such as the provision of quarterly management information.
- Loans are not very flexible - you could be paying interest on funds you're not using.
- You could have trouble making monthly repayments if your customers don't pay you promptly, causing cashflow problems.
- In some cases, loans are secured against the assets of the business or your personal possessions, eg your home. The interest rates for secured loans may be lower than for unsecured ones, but your assets or home could be at risk if you cannot make the repayments.
- There may be a charge if you want to repay the loan before the end of the loan term, particularly if the interest rate on the loan is fixed.
When loans are not suitable
It is not a good idea to take out a loan for ongoing expenses, as it may be difficult to keep up repayments. Ongoing expenses are instead best funded from cash received from sales, possibly with an overdraft as backup.
If you cannot obtain a loan or other type of finance from your bank, there are other finance options available to you. For more information, seebusiness financing options - an overview.
FAQs
In conclusion, traditional banking offers a range of advantages such as personalized customer service, physical branches, and a sense of security and trust. However, it also has its drawbacks, including potential fees, limited accessibility, and lengthy processes.
What are the advantages and disadvantages of bank loans? ›
Bank loan
| Advantages | Disadvantages |
|---|
| Can be arranged quickly | Interest has to be paid in addition to the loan amount |
| Loan can be repaid over a long period of time | |
In conclusion, traditional banking offers a range of advantages such as personalized customer service, physical branches, and a sense of security and trust. However, it also has its drawbacks, including potential fees, limited accessibility, and lengthy processes.
What are the disadvantages of applying for a bank loan? ›
Disadvantages of a Bank Loan
Complicated: Obtaining a bank loan is extremely time consuming. You will be required to fill out excessive paperwork, and the terms of interest will be quite complicated. The process will not be quick either, often, it takes several months to qualify and obtain capital from a bank.
What do you think are the advantages and disadvantages of bank loans as a means of financing compared to the sale of equity or debt? ›
Because equity financing is a greater risk to the investor than debt financing is to the lender, debt financing is often less costly than equity financing. The main disadvantage of debt financing is that interest must be paid to lenders, which means that the amount paid will exceed the amount borrowed.
What are 3 advantages of banking? ›
Benefits of a Bank Account
- Bank accounts offer convenience. For example, if you have a checking account, you can easily pay by check or through online bill pay. ...
- Bank accounts are safe. ...
- It's an easy way to save money. ...
- Bank accounts are cheaper. ...
- Bank accounts can help you access credit.
Interest rates and repayment amounts are fixed at the outset, making it easy to plan your budget and predict spending. Bank lenders do not share ownership of your company. Interest rates on bank loans are usually lower than that in other financing methods (e.g. inventory and invoice financing).
What are the advantages of a loan? ›
Consider the potential advantages:
- Flexible Use.
- One Lump Sum.
- Fast Funding.
- They Can Help Build Your Credit Score.
- Higher Borrowing Limit Than a Credit Card.
- Lower Interest Rates Than a Credit Card.
- Predictable Repayment Schedule.
- Flexible Repayment Terms.
Although borrowing money may seem like a good idea if you're strapped for cash, there are times when getting a loan may be a bad idea. While it's true a personal loan can be used for almost any reason, interest charges can add up, and your credit may take a hit if you miss payments.
What are the risks of bank loan funds? ›
Bank loans are subject to heightened prepayment risk. Liquidity and Valuation risk: Loans are unregistered securities, trade over-the-counter and may have periods of imbalanced trading activity causing periods of illiquidity and price volatility.
Borrowing money allows you to support aspects of your business which you may not be able to afford. Yet even if you do have the good fortune of possessing sufficient capital, parting with your savings could cause issues later in your business' development and limit your ability to build a reputable credit rating.
What are the advantages and disadvantages of term loans? ›
Term loans offer businesses a fixed sum of cash to address specific needs over a period of time. While a fixed rate term loan provides stability, predictable repayment terms, and flexibility, an adjustable rate loan can typically offer a lower initial rate but less predictability in the future.
What is the advantage and disadvantage of a personal loan? ›
Personal loans tend to carry lower interest rates than credit cards, which can make them more affordable for borrowers. Before deciding to get a personal loan, you must consider potential downsides, such as high interest rates, steep fees and a hit to your credit score if used incorrectly.
What is a negative of a bank loan? ›
Loans are not very flexible - you could be paying interest on funds you're not using. You could have trouble making monthly repayments if your customers don't pay you promptly, causing cashflow problems. In some cases, loans are secured against the assets of the business or your personal possessions, eg your home.
What are some advantages of banks? ›
- Your money is safe. ...
- Your money is protected against error and fraud. ...
- You get your money faster with no check-cashing.
- You can make online purchases with ease and peace.
- You have access to other products from the bank. ...
- You can transfer money to family and friends with.
- You have proof of payment.
