What are Bank Loans? Advantages and Dis-advantages of Bank Loans?

They are typically a simple and quick approach to get the necessary cash, and are typically supplied over a specified length of time. Bank loans can be tailored to match the business’s needs whether they are capital/principal repayment or interest-only. Commercial mortgages are widely accessible and often offer flexible terms for businesses looking to purchase commercial real estate. Bank loans can be short or long-term in duration, depending on the loan’s purpose.

Commonly Used For?

Bank loans are regularly utilized to finance startup capital as well as major, long-term acquisitions.

Costs

There are five primary direct costs to consider:

  • Fees for arrangement, interest, insurance, and covenant compliance, as well as expert assistance.
  • Bank loans are often charged an interest rate based on the amount outstanding. Additional fees and charges may apply, depending on the loan type and lender.
  • Arrangement fees are commitment or administrative fees that must be paid to the lender in order to reserve cash and cover starting costs. Fees will vary according to the complexity, size, and risk of the firm.
  • Interest is assessed and varies according on the risk of default. The two most prevalent types of interest rates are fixed and variable (a margin over base rate or London Interbank Offered Rate [LIBOR]).
  • Insurance, particularly key person insurance, may be required as a condition of loan approval. The levels and costs of this insurance vary, obviously depending on the insured person’s health history.
  • Generally, better rates can be achieved when the bank loan is secured, since the lender’s risk is reduced. The borrower’s security may include corporate assets, personal guarantees or security, or third-party guarantees or security.

This also occurs when the lender requires loan covenants or other information as a condition of issuing the loan or ensuring the loan’s continuous availability. Regular requests for information such as current management accounts and/or cash flow projections can be made, which will be agreed upon prior to sanctions. As a result, the expenses of developing and distributing such information should be considered prior to enter into a contract with a lender.

Legal expenses vary according to whether additional services are offered, the complexity of the firm, its size, and the lender’s risk. When a personal asset, such as a jointly owned property, is used as security, fees are likely to apply.

Fees for management accounts preparation vary according to whether additional services are offered, such as bookkeeping, and also according to the complexity of the business, its size, and frequency of issuance. Typically, a business would pay between £250 and $1,000 for each preparation.

Timeframe

The time required to secure a bank loan varies according on the state of readiness of the firm and the type of loan sought. Unsecured loans often take one to four weeks to process, whereas secured loans typically take two to three months.

Timings will also vary depending on whether additional security, valuations, or legal advice are required.

Advantages

  • Ideal for borrowing on a medium- to long-term basis
  • The loan size, time, repayment schedules, and interest rate can all be customized to meet the needs of the business, including cash flow and income generation repayment holidays.
  • Because funding is not contingent on the sale of a business, this sort of borrowing typically carries a lower interest rate than more flexible (ie short-term) borrowing.
  • Generally, interest and arrangement costs are tax-deductible.
  • Matching fixed assets and long-term debt improves the balance sheet’s net asset position, while regular loan repayments may help the business’s credit score.

Disadvantages

  • Not as adaptable as short-term fixes. For instance, if the loan is repaid early, additional fees may apply; the lender may not grant the entire amount requested, as the business’s financial situation will be considered.
  • If the loan is secured and the business defaults, the lender may take action to seize the security provided for the loan.
  • Not appropriate in circumstances when determining the amount of funding required is challenging, as effort will need to be spent drafting management accounts and monitoring covenant compliance
  • A loan is not flexible and may not be the optimal use of resources for organizations with shifting financing needs.
  • Failure to make loan repayments on time can result in a decrease in credit score, increased interest rates on existing and future loans, collateral seizure, and legal action against the business. Directors of the company may potentially be personally impacted, depending on the loan’s arrangement.
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About the author: Qazi Shabaz

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