Traditional loans are often the most desirable for small business owners – after all, as their name suggests, they’re a tried-and-true funding option. However, the sheer number of loan options available to potential borrowers can obscure what is considered a traditional loan. Additionally, each type of traditional loan will have specific terms and conditions that give them unique benefits and drawbacks.
This all might make you wonder: How can you know which traditional loan is right for you? And how can you know whether traditional loans fit your needs? Below, you can find additional information about what traditional loans are, and how they might be able to help you grow and strengthen your business.
A traditional loan is any loan, paid in installments, that a bank offers to small business borrowers. Bank term loans and SBA loans fall under the “traditional loan” umbrella. Below is more information about each of these types of traditional loans.
Each of the traditional loans listed above has specific characteristics that differentiate them from other financial options, which can vary slightly between loan types and lenders, but almost always have the following:
Traditional loans will have either variable or fixed interest rates. For example, SBA 7(a) loans have variable interest rates, whereas bank term loans have fixed interest rates.
Variable interest rates, as their name suggests, change over the loan’s term according to the prime rate set by the Federal Reserve. This rate fluctuates based on the economy, though in many cases, variable rates mean less expensive loans in the long run.
Fixed interest rates, such as those for bank term loans, don’t change during a loan's lifespan. In practice, the only way to change a fixed interest rate is to refinance the loan through a different lender. While loans with fixed interest rates often start with higher rates, your monthly payment will be unaffected by changes in the economy, leading to better budget predictability.
Traditional loan interest rates are typically lower than other funding options. SBA loans, for example, have lower interest rates and more borrower-friendly terms because the government guarantees a significant part of them. That reduces the lender’s risk, so they don’t have to charge as much for their loans. Non-traditional lenders, such as alternative or online lenders, typically work with riskier borrowers, so they often keep their interest rates high in case a borrower defaults.
Traditional loan amounts are often higher than non-traditional loans. While there’s no one factor underlying this, the most prominent reason has to do with the type of customer doing the borrowing.. Most traditional lenders are highly risk-averse and won’t lend to borrowers with a debt-to-income ratio of greater than 36 percent. This lower-risk lending means these lenders can more safely provide larger loans.
Another reason is traditional lenders often cater to business owners with more expensive financing needs. For example, traditional loans are the go-to for commercial real estate purchases, which are often on the order of millions of dollars. Regular bank term loan amounts range from $30,000 to $500,000 and SBA 7(a) loan amounts range from $30,000 to $5 million.
While the life of a loan can differ depending on several factors, traditional loans often offer longer repayment periods than other options. Typical short-term loans from non-traditional sources often have repayment periods of six to 18 months. Traditional loans instead have loan terms of one to 25 years. Bank term loans are on the shorter end of this range, with payment terms spanning two to five years. SBA 7(a) loans make up the longer end, with terms of either 10 or 25 years.
Traditional loans often require collateral to minimize the lender’s risk. Collateral is an asset (such as your home or car) that can be seized in the event you can’t make the payments on your loan. . If you fail to repay your loan, the lender can take and sell the collateral to pay off the rest of the loan’s balance.
Acceptable collateral depends on your loan amount and type. Financial institutions usually accept easily liquidated assets such as stocks, bonds, real estate, company vehicles, and inventory for small business loans. The value of all your collateral assets must be equal to or greater than your loan amount.
Since traditional loans offer high loan amounts with favorable borrowing terms, there is, generally, a pretty high bar to qualify for them. Three of the most important factors that influence a borrower’s eligibility are as follows.
As a result of their strict eligibility criteria, traditional loans often come with longer application processes. The application itself can take up to an hour – sometimes more – to complete, depending on how prepared you are with your documents when you start. How long it takes the application to process depends on the lender and the type of loan. If you work with SmartBiz to secure an SBA loan, once the application is approved, funds can be deposited into your bank account in as few as 7 days.
Banks and similar lending institutions typically offer traditional loans. Banks fund term loans and SBA loans, though the government guarantees part of SBA loans to try to ensure that high-value financing is more accessible to the average applicant, and that lenders can confidently make more loans.
Applying for traditional loans is often time-consuming, but being prepared can simplify the process. Below is an overview of the necessary steps to complete an application so that you can go in more prepared.
The maximum loan amount that traditional institutions will offer a borrower can differ from lender to lender. To determine which financial institution best meets your needs, consider identifying the exact need you’re trying to fulfill and how much it costs.
You’ll need several documents to confirm your identity and help lenders determine your eligibility. Some documents you’ll likely need include, but are certainly not limited to:
After you determine how much capital you need and which lender may be able to help you attain it, it’s time to complete the application. Filling out the necessary forms can take 15 minutes to an hour. Mistakes can cause the lender to send the application back to you, prolonging this part of the process.
Once your application has been approved, the lender will provide an overview of the exact loan terms, including your loan amount, repayment term, interest rates, and other relevant conditions.
Processing traditional loan funds often takes time. A standard bank loan term can take two to three weeks to fund, while an SBA loan can take up to three months. Once you receive your loan, you can use it for business expenses within the parameters set for the type of loan. For example, SBA 7(a) loans can only be used for working capital, debt refinancing, or commercial real estate purchases.
Lastly, you’ll set up your monthly payment schedule. With traditional loans, the longer your repayment period, the less you’ll typically have to pay per month.
Traditional loans are generally for borrowers with an established business or prior business experience, as well as good credit. The SBA works to open traditional loans to small business owners who wouldn’t usually qualify or applicants who want to fund a startup.
Traditional loans are valuable funding sources if you qualify. Their higher loan amounts and longer repayment terms can help you affordably achieve your business goals. Although the application process for a traditional loan can be time-consuming, it’s faster with SmartBiz®. Check now whether you pre-qualify* for traditional loans based on your finances.