Comparing Small Business Funding: Banks vs. Private Lenders

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Category: Loans
Posted on: 11/11/2020
A bank manager holds a pen over some paperwork while facing a couple applying for a loan

When you’re looking for funding for your small business, there are many options available. But which is the best option for you as a small business owner? Let’s look into the two types of funding institutes: banks and private lenders.

Both types of lenders assess your risk as a borrower, in slightly different ways. Banks will use your personal credit history to assess risk, while private lenders will use your business bank statements to create financial statements that are then used to assess your risk. No matter which you choose, understanding your risk as a borrower is something you should consider when you’re looking for small business funding.

Now let’s compare the pros and cons of the different types of business financing available to you.

Traditional Funding Through a Bank

With a bank, you can apply for either a loan or a line of credit. We go over the difference between a loan and a line of credit in this article. Both will get you the cash your small business needs, both have to be repaid, and both require good credit.

Bank Loan

When you apply for a bank loan, you will be asked for quite a bit of information up front. Usually, a bank will ask for upfront collateral, 2-3 years of your tax records, and proof of income. The bank will loan you money based on their assessment of this information. If you have a good credit score, you may be eligible for a larger loan amount or a lower interest rate. This can be one of the less expensive methods of getting funding for business owners, with long payment terms allowing plenty of time to pay back the loan. And with a loan, there are generally no penalties for pre-paying the balance.

Line of Credit

On the other hand, a line of credit can be the cheapest way for small business owners to obtain funding. Interest rates are usually low and the repayment terms are flexible. You only need to get qualified once for a set amount, and you can borrow any amount within this limit. However, qualifying for a line of credit as a small business owner can be difficult, and the process can take as long as 60 days. There are strict qualification criteria, and your personal credit score makes a big difference in your maximum credit limit.

Private Lenders

In addition to traditional small business funding like loans and lines of credit, there are also private financing companies that serve more specialized needs. Focusing more on customer service and convenience, they find innovative ways to finance small business owners. Typically more expensive than banks, private lenders can be faster and less strict. Additionally, the application process can often be completed entirely online. 

Some drawbacks to keep in mind when considering a private lender include high interest rates, pre-payment penalties, and lower funding amounts. But if your personal credit score isn’t so great, or if you need financing for your small business fast, a private lender may be the way to go.

Which Type of Financing is Right for You?

As you now know, the requirements for getting funding from a bank or a private lender vary quite a bit. As a borrower, there are pros and cons to each option that you’ll want to consider. For example, to even consider applying for a bank loan, you’ll need to have a good personal credit score (over 650). But a private lender will usually only need to see that your business generates enough revenue to pay the borrowed money back.

The funding method you ultimately choose will depend on your circumstances. Do you need cash fast, or do you have time to go through a longer process in exchange for a lower interest rate? How’s your personal credit score? And how much money does your small business need? By answering questions such as these, you’ll soon be on your way to getting the financing you’re looking for.

Finance Guru

Finance Guru