Whether you are planning to start a business, buy inventory for an existing one or expand operations, you probably need a substantial amount of money. If you don't have the money lying around, you'll need financing. One of your financing options is to secure a bank loan. These loans offer certain tax breaks and have lower interest rates compared to credit cards and overdrafts. However, you must meet a range of loan requirements and the burden of repayment can wear you down.
Bank Loan Advantages
Flexibility: With bank loans, you only need to worry about making your regular installment payments on time. This is an advantage over overdrafts, where you must pay the full amount when the bank demands it. In addition, banks don't usually monitor how you use your loan as long as you make your payments on time, so you can invest it however you deem fit.
Cost Effective: In terms of interest rates, bank loans are usually the cheapest option vs. overdrafts and credit cards. According to Bankrate, as of October 2018, the average fixed interest rate for credit cards has surged to 17.49 percent, while certain bank-provided loans guaranteed by the Small Business Administration have rates ranging from 7.5 to 10 percent. The lower interest rates of bank loans will definitely save you money.
Retained Profits: While businesses that issue equity to raise capital often give a percentage of their profits to shareholders, banks require borrowers to pay only the principal and interest amount on a loan. As such, you will retain all your business profits.
Tax Benefits: When you use a bank loan for business reasons, the interest you pay on the loan is a tax-deductible expense. For example, if you are paying a 5 percent interest rate on a $30,000 loan, then your yearly interest is deductible on your 1040 Schedule C tax form.
Bank Loan Disadvantages
Strict Requirements: Because many bank loans require some form of collateral, startups and existing businesses without any assets can find it difficult to get their loan applications approved. If these borrowers choose to go for unsecured loans, they are hit with higher interest rates.
Repayment Burden: Loan borrowers must make periodic payments to their banks. Those who fall behind on payments face the prospect of having their assets seized. Even if you manage to make late payments, your bank could still report you to credit bureaus – a move that negatively affects your credit score. With a lower score, obtaining loans in the future becomes more difficult. The repayment burden is a disadvantage compared to raising money through shareholders, because shareholders don’t require regular repayments. Instead, they are typically paid dividends only on profits.
Irregular Payment Amounts: If you get a bank loan with a variable interest rate, the rate changes with market conditions. This makes it difficult to determine the exact amount of future payments. Consequently, it becomes challenging to make sound financial plans.