This is a condensed version of an article by OnDeck. Reprinted with permission.
By Ty Kiisel
Before you get a small business loan, there some important questions you need to ask — 3 to ask yourself and 5 to ask your potential lender.
Ask Yourself: What do I need the loan for?
It seems like a pretty straightforward question, but it’s a question often overlooked by borrowers. Articulating the purpose of the loan will help answer some of the other questions you’ll need to ask.
Specifically, your loan purpose will help you identify whether you’re trying to fill a short-term or a long-term need. For example, the financing needs when you’re purchasing quick-turnaround inventory are decidedly different from when purchasing an expensive piece of heavy equipment. It seldom makes sense, for example, to borrow with a four- or five-year term to pay for inventory that will be sold in a month or two.
Ask Yourself: How much money am I looking for?
More isn’t always better. When I ask a borrower how much they’re looking for and the reply is, “As much as I can get,” I cringe. This answer tells a potential lender that you haven’t really thought through your loan purpose. Your loan purpose should drive the answer to this question.
Some people say you should borrow as much as you can at any opportunity you have, because you never know when you won’t be able to borrow again. I disagree. There are costs associated with borrowing that should be thoughtfully considered every time you seek borrowed funds.
However, if the borrowed funds will drive increased returns on investments (“ROI”) or add value to the business, a small business loan could make a lot of sense. In other words, borrow what is required to fulfill your business need.
For comparison, according to a recent survey by the Electronic Transactions Association (ETA), the average loan amount for an online business loan was $25,000. And the average number of times those business owners had borrowed over the past five years was three.
Ask Yourself: How quickly do I need the funds?
Some needs don’t allow the luxury of time to wait for several weeks to gain a loan approval. For example, to serve a new customer contract, you might require additional capital within the next few days — waiting weeks for a small business loan could carry with it an opportunity cost that is too high.
63 percent of the ETA survey respondents listed speed of funding as the primary reason they chose the loan they did, indicating the importance of this question (and another reason why your first question should be, “What do I need the extra capital for?”)
Now you’re ready to talk to a lender. You want to evaluate a potential lender based upon whether or not they’re a good fit for your business.
Finding the right lender can make the difference between successfully using a business loan to create value in your business, or putting your business’ viability at risk.
Ask Your Potential Lender: Do you offer a loan term that fits my business need?
Because you’ve identified your loan purpose (your business need), you can determine whether or not you’re looking for a short-term or a long-term loan.
There are lenders that offer exclusively either short-term or long-term loan options. In much the same way most consumers wouldn’t purchase a new car with a 30-year auto loan, you probably don’t want a long-term loan for a short-term need.
Ask Your Potential Lender: What are the interest rates and the total cost?
APR (Annual Percentage Rate) and dollar cost are two things you should consider.
The APR calculation includes all fees, including interest and origination fees. As the name suggests, it’s expressed as a percentage rate for a year, even if you only plan on holding a loan for a few months.
Total dollar cost tells you, in actual dollars, how much money your loan will cost you. For example, if you were to borrow $10,000 and your total payback was $11,500, your total dollar cost would be $1,500.
Whatever numbers you’re looking at, make sure you compare apples to apples. For example, compare APR to another APR and not just the annualized interest rate.
Ask Your Potential Lender: How do I make my payments?
While some lenders still accept payments by paper check, many lenders (including online lenders) have turned to automatic debits from a business’ bank account.
Lenders like automatic debits because it’s easier to collect and manage payments.
They can be good for businesses, too. There’s less work for you (no checks to write, no stamps, envelopes or trips to the bank); and every payment is made on time, which helps you build a strong business credit profile.
Make sure you understand exactly what will be debited from your account with each periodic payment. Will it be a fixed amount or will it fluctuate depending upon what’s in your account? If you’re making daily payments, does that mean every day or every business day?
While you’re at it, ask your lender what happens if there aren’t enough funds in your account when the periodic payment is due. A good lender should be willing to work with someone who proactively comes to them with an isolated problem. They want to see the loan process be successful as much as you do.
Ask Your Potential Lender:
How long will the loan application process take?
Depending upon the lender it could take anywhere from a day or two to several weeks—or even months. Depending upon your loan purpose and how quickly you would like the capital, there may be some lenders you weed out early in the process because their typical approval process just takes too long.
Fortunately, there are lenders who are able to offer a quick decision. Lending by Wave, powered by OnDeck, is one of them. In many cases, you can get approved and have funds in your account as quickly as 24 hours or less.
Ask Your Potential Lender: Do you report my credit history to the business credit bureaus?
If they don’t report, your good credit behavior doesn’t help you build an even stronger business credit profile for your future needs. There are some lenders, like merchant cash advance providers, that don’t. So don’t assume the lender you’re interviewing with does. This should be an important consideration when you’re looking for a small business loan.
—Ty Kiisel writes about small business and small business finance for OnDeck, and outlets like Forbes.com. An expanded version of this article, with additional questions for you and your potential lender, is available at OnDeck.