How Do Business Loans Work?

Business loans work like personal loans, but are designed specifically to be used by businesses.
A business loan can be secured or unsecured, depending on whether an asset is or isn’t needed as security for the loan.
Whether you’re offered a loan can depend on factors such as your business’s finances, credit history, and reason for wanting a loan.

Table of Contents

What is a business loan?
What are the different types of business loan?
Pros and cons of business loans
What are business loans used for?
How long does it take to get a business loan?
How much can you borrow through a business loan?
What are typical terms for a business loan?
What if I can’t repay my business loan?
What is the right loan for my business?
Am I eligible for a business loan?
Can I get a business loan?
Applying for a business loan
Find the right business loan for you

A business loan works by letting you borrow funds for use by your business, which must be then repaid, plus interest, in regular instalments over a set period of time.

Several different types of business loans are available, including start-up business loans, secured loans and unsecured business loans. This article focuses on these standard business loans, rather than specialist forms of business finance such as invoice financing, merchant cash advances, and asset finance.

What is a business loan?

As the name suggests, business loans are targeted for business use and can range in length from just a few weeks to several years.

Business loans work much in the same way as personal loans. You apply to borrow a specific amount from a lender, such as a bank or online lender, and it will assess whether it wants to lend to you and, if so, at what interest rate.

If it makes you an offer, you can decide if the lender’s terms are acceptable. If you proceed, the loan amount is transferred to your company’s business bank account. You will then need to gradually repay the loan amount, plus interest, over the loan term you’ve agreed with the lender. Repayments are usually made monthly, though some lenders offer weekly repayments.

Assuming payments are made in full and on time, everything owed should be paid back by the time the loan term ends.

» MORE: What is a business loan?

What are the different types of business loan?

There are several types of business loans, but the two common options are unsecured loans or secured loans.

Unsecured loans

Unsecured loans mean that you can borrow money without using a business asset – which is anything of value such as property, machinery or stock – as security for the loan.

As unsecured business loans do not come with an asset as security, they are likely to attract a higher rate of interest, meaning the total you pay back will be higher than with a secured loan. However, the advantage of an unsecured loan is that you are not directly at risk of losing an important asset if you cannot repay the loan.

Bear in mind that some unsecured business loans may require a personal guarantee. This is when a business owner or director takes on the responsibility of repaying the loan from their personal funds if the business is unable to.

Secured loans

A secured loan means that you are obliged to put up an asset, such as property, machinery or stock, as security for the loan. If you are unable to repay the loan or fall significantly behind on repayments, then you are at risk of the lender seizing that asset.

Because the asset reduces the risk for lenders (as they can get their money back from your asset if you miss repayments), interest rates will often be lower than for unsecured loans.

» MORE: Finding the right type of business loan

Pros and cons of business loans

Before applying for a business loan, there are a number of advantages and disadvantages to weigh up:

Pros	Cons
They can be used for a range of purposes, from growing your business to covering cash flow problems.	You may have a smaller choice of lenders, and pay a higher interest rate, if you have a poor credit rating.
They can help spread the cost over a set period of time if buying expensive items, such as office equipment.	If your business loan is secured against an asset, you could lose that asset if you don’t keep up with repayments.
If your interest rates are fixed, you will know exactly how much you need to repay every month.	You may have to pay an early repayment fee if you want to pay off your loan before the end of the term.
You will not give away any equity in your business to secure a loan.	Business loans may not always be a suitable solution if you are in financial difficulty.

» MORE: Pros and cons of bank loans for businesses

What are business loans used for?

Lenders usually want to know what a business loan will be used for before deciding whether to lend. For instance, business loans cannot be used for personal reasons, such as a new family car, a holiday or paying off personal debt.

There are many different reasons why businesses take out business loans but some common purposes are:

Covering startup costs

Starting a new business usually comes with set-up costs that could be covered by a business loan.

Cash flow

A business loan can help cover short-term cash flow challenges, including if your business is seasonal, and funds run short at certain times of the year.

Buying equipment and/or stock

A business loan can be used to help meet the cost of purchasing new equipment or stock that your business needs.

Purchasing premises

If your business requires premises or has outgrown its current home, a business loan can help with this potentially significant cost.

Short-term operating costs

Some business owners may need a loan to help cover the day-to-day costs of running a business, such as rent or utility bills.

Debt consolidation

Bringing together and consolidating existing debt into a single business loan can make debts easier to manage and potentially lower interest costs, with the right loan.

Growing your business

Business loans can be used to help your business take the next step. This may be by paying for marketing and advertising, allowing you to invest in hiring and training new staff, or providing the funds to expand into new products and services, or buy another business.

» MORE: How to grow your business

How long does it take to get a business loan?

How fast you can get a business loan depends on the lender, the type of loan you want and how quickly you can provide the information a lender needs. It may be possible to apply for a business loan online in a matter of minutes, and receive the funds the same day. However, some business loans may take several weeks or even months to arrange. For instance, there’s likely to be a lengthier legal process involved with a secured loan due to having to use an asset as security for the loan.

How much can you borrow through a business loan?

The minimum amount that can usually be borrowed through a business loan is around £1,000, while large business loans may be available for several hundreds of thousands, or even millions, of pounds. Exactly how much you can borrow generally depends on the lender, the financial position of you and your business, and the size of loan the lender thinks you can afford.

What are typical terms for a business loan?

The range of loan terms on offer varies between lenders. Some business loans can be repaid over a period of 10 years or perhaps more, up to 25 years. Or if you intend to pay the loan off faster, it is possible to find loan terms for as short as three months to a year.

What if I can’t repay my business loan?

If you fail to keep up with your loan repayments, you may be charged a late or missed payment penalty fee, face higher interest rates, or lose any assets which you put up as security for the loan. Missed payments could also be marked on your business’ credit history and your own, potentially leading to lower credit scores.

If you’ve provided a personal guarantee, it becomes your personal responsibility to pay what is owed from your own assets, potentially even if it means selling your residential home. Eventually, there may be court proceedings, and it’s possible your business could be wound down.

Always talk to your lender or seek professional advice at the earliest opportunity if you’re struggling to keep up with repayments.

What is the right loan for my business?

Choosing the right loan for your business is a crucial decision. You need to weigh up a number of factors that will determine what the right loan is for you. These include:

How much you want to borrow

Estimating carefully the loan amount you need can save time and effort having to apply for further loans. It can be sensible to include a contingency amount in case costs rise unexpectedly.

However, also remember that you will have to pay interest on the whole of the loan, so if you borrow too much for your needs you will be incurring unnecessary costs.

How much you can pay back each month

This will help determine how much you can borrow and how long you set the loan term for paying the loan back. A lender will assess how much it feels you can afford to repay, and therefore the amount it will let you borrow. A shorter loan term means you will pay less in interest, but your monthly repayments will be higher than if you are borrowing the same amount over the long term. Use our business loan calculator to get an idea of monthly repayments and what you could afford. .

Whether you want a fixed or variable interest rate

Business loans either come with a fixed rate, where the interest rate is fixed for the length of the loan, or a variable rate, which can change.

With fixed-rate business loans, you know exactly how much your repayments are each month, making it easier to budget and plan. If interest rates go up generally, you also have the security of knowing your repayments won’t rise. That said, if rates go down, you could miss out on potential savings.

With variable rate loans, you could benefit from a fall in interest rates, which would reduce your monthly payments. However, it is also likely that your repayments will rise if interest rates go up.

If there are any extra fees and restrictions

Always take time to understand the charges, features, and terms and conditions of a loan. Some business loans may have administration or application fees. There may also be early repayment charges if you want to pay off your loan early. Equally, it’s sensible to check if a loan gives you the option to borrow more, alter the repayment term, or change your repayment amount if necessary.

Am I eligible for a business loan?

Generally you must be at least 18 years old, a UK resident, and own or want to start a UK-based business to qualify for a business loan.

Further eligibility criteria tend to differ between lenders, particularly with requirements around minimum turnover and length of trading history.

Can I get a business loan?

Whether you’re offered a business loan, and the amount you can borrow, will depend on many factors. These typically include the financial situation and credit history of your business, and the reason for wanting a loan.

Lenders may also check your personal credit history to assess how you manage your finances. For a young or new business, your business plan and forecasts will be important in demonstrating the viability of your venture.

While it may be possible to get a loan with a less-than-perfect credit history, your loan options are likely to be fewer, and interest rates probably higher, than with a better credit score. You may also find you’re asked to provide some security for the loan or a personal guarantee.

Applying for a business loan

Depending on the loan provider, you may be able to apply for a business loan online, in a branch, or perhaps over the phone.

Make sure your business finances are in order as lenders will want to know information about your business income and expenditure.

For example, they may want to see bank statements and accounts showing your cash flow to help them work out if you can afford a loan. They may also ask for a business plan to show how you would use the loan and your financial forecasts.

If you’re applying for a secured loan, the lender will need to confirm the value of the asset you’re putting forward as security.

» MORE: How to get a business loan

Find the right business loan for you

A business loan can be used to push your company to the next level or help your business aspirations become a reality. There is much to consider, including the different loan options and the potential risks. But NerdWallet is ready to help you find a business loan to suit you.

» MORE: Compare business loans

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How Do Business Loans Work?

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