How are Business Loans structured?

Business loans are structured in many different ways. However, ultimately, they can be broken down into two vital aspects to their make up. The first is the interest rate and the second is the way the loan is repaid (otherwise known as the repayment schedule).

Interest rates tend to come in two types - fixed and variable. A fixed rate loan sees the interest on the loan remaining constant throughout the repayment period. The interest rate is determined by the risk involved in lending the money and the current rates in the market. The variable rate sees the interest that is applied on the principal outstanding fluctuating with changes in the LIBOR or the Bank of England base rate. This means your payments are variable as well. The current market rate will be added to a predetermined premium which is a constant throughout the loan.

The variable interest rate loan offers the advantage over the fixed rate should the market rate decrease, because you will end up paying less than you would have on a fixed rate. Conversely, the disadvantage is in the fact that you have no protection from increases in the market rate, which could take your monthly payments above what they would be should you have a fixed rate loan.

Ultimately, when deciding on your repayment schedule you should always bear in mind one thing - the longer your payback period, the more interest you will actually have to pay in total.

The simplest repayment schedule is that of equal payments, where the amount you pay per period is equal and you pay over a specified number of periods. Each payment goes partly towards interest and the rest to the principal. When the specified number of periods is up, you will have repaid the loan plus interest.

Repayments made with equal payments and a final balloon payment see equal payments made of capital and interest for a short period of time, followed by a last instalment, called a balloon payment. You get lower monthly payments with this, but don't forget the size of the balloon payment at the end.

Should you want even lower monthly payments, you can take an interest-only repayment schedule with a final balloon payment, although you will pay more interest on this in the end as you borrow the principal for more time.

Some lenders will allow you to make one payment at a specified date, including the principal and accrued interest. This is useful for short term loan where you have immediate cash needs which you know you can cover later.

Finally, you can choose to pay equal principal payments each period. This will give you high monthly payments at first but will decline, as your principal reduces faster than normal.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

© AskFinancially.com 2008

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