Traditional loans are among the most popular choices for small business owners. However, when you consider the number of loan options available, it’s often hard to determine what a traditional loan is and if it's the right choice for your business. Understanding the basics about traditional loans, including their potential pros and cons, allows you to make the right choice for your company.
This might make you wonder how you can know whether traditional loans fit your needs, and if so, which type is right for you. Below, you can find additional information about what traditional loans are and how they might be able to help you scale your business.
What is considered a traditional loan?
A traditional loan is any loan that is paid back in installments. Bank term loans and Small Business Administration (SBA) loans fall under the “traditional loan” umbrella. Below is more information about each of these types of traditional loans.
- Bank term loans - These loans are any small business funding options that banks offer and you repay in monthly installments. They are among the most sought-after types of small business financing. You can obtain them from big-name national banks, local credit unions, and other types of financial institutions. They typically require less paperwork and collateral than SBA loans, and you can use them for a broad set of business needs. Since they have fixed interest rates, borrowers don’t have to worry about their monthly payments going up based on Federal Reserve decisions. SmartBiz Bank® works with countless business owners each year to offer them the bank term loans they need for their companies.
- SBA loans - These loans are backed by the Small Business Administration. This government backing mitigates the risk banks take in providing these types of loans, even if the SBA doesn’t fund them or directly provide them. There are several types of SBA loans. These are the three most common types:
- SBA 7(a) loans - Many small business finance experts consider an SBA 7(a) loan to be the best traditional loan. Benefits typically include long repayment periods of up to 10 years, lower interest rates, and large loan amounts. While there are restrictions on how you can use SBA 7(a) loans, a small business can use them to fund working capital, debt refinancing, or commercial real estate purchases. SmartBiz Bank offers SBA loans. Learn more on the SmartBiz website: Get great rates, long repayment terms, and low monthly payments with SBA loans.
- SBA 504 loans - You may qualify for these loans if your funding use aligns with the goals of your local community development corporation (CDC). Often, these loans help borrowers obtain long-term financing to purchase large equipment or real estate. Their benefits are similar to those of SBA 7(a) loans.
- SBA microloans - These loans are traditionally available to new or very small businesses. Their loan amounts are at most $50,000, which you can use for working capital, fixtures, furniture, inventory, supplies, machinery, or equipment. They’re one of the very few government-backed long-term business loans for those who may have issues with their credit.
Key facts about traditional loans
While all types of bank rate loans have their own unique characteristics, they also have a lot in common. Virtually all bank rate loans share the following traits.
Variable or fixed interest rates
Traditional loans have either variable or fixed interest rates. For example, SBA 7(a) loans have variable interest rates, while 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. The only way to change a fixed interest rate is to refinance the loan through a different lender. While loans with fixed interest often start with higher rates, your monthly payment will be unaffected by changes in the economy, leading to better budget predictability.
Lower interest rates
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 portion of them. That reduces the lender’s risk, so they don’t have to charge as much for their loans.
Higher loan amounts
Traditional loan amounts are typically higher than those of non-traditional loans. While no one factor makes this case, the most prominent reason has to do with the type of borrower who seeks these loans. Most traditional lenders are highly risk-averse and won’t lend to borrowers with a debt-to-income ratio of greater than 36%. This lower-risk lending means these lenders can provide larger loans more safely.
Another reason is that 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 often involve millions of dollars. Regular bank term loan amounts range from $30,000 to $500,000, while SBA 7(a) loan amounts range from $30,000 to $5 million.
Longer repayment terms
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 nontraditional sources often have repayment periods of 6 to 18 months. Conversely, traditional loans have loan terms of anywhere between 1 and 25 years. Bank term loans are on the shorter end of this range, with payment terms spanning 2 to 5 years. SBA 7(a) loans make up the longer end, with terms of either 10 or 25 years.
Often requires collateral
Traditional loans often require collateral to minimize the lender’s risk. Collateral is an asset (such as your home or car) that a lender can seize in the event you can’t make the payments on your loan. If you fail to repay your loan, the lender can sell the collateral to pay off the balance of the loan.
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.
Strict application criteria
Since traditional loans offer high loan amounts with favorable borrowing terms, there is generally a pretty high bar to qualify for them. These are three of the most important factors that influence a borrower’s eligibility.
- Credit score. The higher your credit score, the more likely traditional lenders are to trust that you can repay a loan. Most traditional loans require a credit score of at least 680, though SBA microloans are available if your credit score is at least 620.
- Business experience. Your company must have been in business for at least 2 years before you can qualify for SBA 7(a) and 504 loans. That’s because financial institutions view established businesses as far more likely to have enough revenue to repay loans.
- Business plans. A business plan outlines your long-term financial goals and how you’ll achieve them. It can reassure lenders that you’ll eventually earn enough revenue to repay the loan. Note that SmartBiz does not require a business plan to apply for a loan.
Longer application process
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 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.
Who offers traditional loans?
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.
How do traditional loans work?
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 better prepared.
1. You determine your ideal loan amount and find lenders that can provide it
The maximum loan amount that traditional institutions will offer a borrower differs from lender to lender. To determine which financial institution best meets your needs, identify the exact need you seek to fulfill and how much it costs.
2. You gather the required documents
You’ll need several documents to confirm your identity and help lenders determine your eligibility. These are some documents you’ll likely need:
- Personal tax returns. These help the lender ascertain whether you’re fiscally responsible.
- Professional resume. These verify your professional background, which can help banks mitigate any perceived financial risk.
- Personal background statement. This document provides a snapshot of your background. It includes your criminal record, previous names, previous residences, educational experience, and more.
3. Complete an application
After you determine how much capital you need and which lender may be able to provide it, it’s time to complete the application. Filling out the necessary forms can take 15 minutes to an hour. Proofread your work because mistakes can cause the lender to send the application back to you, prolonging this part of the process.
4. If approved, go over the terms with your lender
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.
5. Await, obtain, and use your funds
Processing traditional loan funds often takes time. A standard bank loan term can take 2 to 3 weeks to fund, while an SBA loan can take up to 3 months. Once you receive your loan, you can use it for business expenses within the parameters set for the type of loan. For example, you can use an SBA 7(a) loan only for working capital, debt refinancing, or commercial real estate purchases.
6. Set up monthly payments
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.
Who can get a traditional loan?
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 start-up.
Is a traditional loan right for your business?
Traditional business loans are often a strong fit for established companies with predictable cash flow and a clear plan for using the funds. Businesses seeking larger, long-term investments, such as expanding operations, purchasing equipment, or refinancing existing debt, tend to benefit most from these loans. They typically offer lower interest rates than many alternative financing options, along with predictable repayment schedules and the ability to plan ahead financially.
However, traditional loans may not be ideal for every situation. Very new businesses or those facing urgent cash needs, might find the application process too slow, and lenders often require strong financial histories or collateral for approval. Compared with alternative financing options like lines of credit or SBA microloans, traditional loans usually provide more favorable rates and longer terms but are less flexible and take more time to secure. Evaluating your business’s needs, timing, and risk tolerance can help you determine whether a traditional loan aligns with your growth strategy.
Apply for an SBA loan with SmartBiz
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 to see if you pre-qualify based on your finances.
FAQs
How do traditional loans differ from alternative financing options?
There are several key differences between traditional loans and alternative options. Traditional loans typically offer lower interest rates, fixed repayment schedules, and longer terms, which can make them more predictable and cost-effective for established businesses. Alternative financing, such as lines of credit, invoice financing, or short-term loans, often provides faster access to cash and greater flexibility but at higher costs or variable rates. Traditional loans usually require stronger financial histories, collateral, and more extensive documentation, whereas alternative financing may be accessible to newer businesses or those with less-established credit. Choosing between them depends on your business’s cash flow needs, growth plans, and tolerance for cost versus speed.
What are the typical requirements for a traditional loan?
Typical requirements for a traditional business loan include a solid financial history, proof of consistent revenue, and up-to-date business financing records such as tax returns, bank statements, and financial statements. Lenders often look for a strong credit score and may require collateral or personal guarantees to secure the loan. Most traditional loans also expect a minimum time in business, usually 1 to 2 years, to ensure stability and repayment ability. Additionally, lenders may review your business plan and cash flow projections to assess whether the loan aligns with your growth strategy. Meeting these requirements helps improve your chances of approval and may also result in more favorable terms.
How long does it take to get approved for a traditional loan?
The approval timeline for a traditional business loan can vary depending on the lender, loan size, and complexity of your application. For most small to mid-sized loans, the process typically takes anywhere from 2 to 6 weeks, though larger loans or more complex financing requests can take longer. The timeline includes reviewing your financial statements, credit history, collateral, and other documentation to assess your repayment ability. Compared with alternative financing options like lines of credit or SBA microloans, traditional loans usually require more documentation and underwriting, which contributes to the longer approval period. Planning and ensuring all required documents are accurate can help speed up the process.
What types of businesses are best suited for traditional loans?
Businesses that are well-established with steady revenue streams and a clear growth plan are typically the best candidates for traditional business loans. Companies looking to make long-term investments, such as purchasing equipment, expanding operations, or refinancing existing debt, often benefit most from the lower interest rates and structured repayment schedules these loans offer.
Lenders generally prefer businesses with a proven financial history, strong business financing records, and sufficient collateral, which makes newer or high-risk ventures less ideal. Service providers, manufacturers, and retail businesses with predictable cash flow are examples of businesses that often fit this profile. Essentially, if your company can demonstrate stability and the ability to meet fixed payments over time, a traditional loan may be the right financing option for you.
