Advantages & Disadvantages of Borrowing Money from the Bank

by Linda Ray

Bank loans can be an effective borrowing tool.

In the early stages of your business, you are unlikely to have all the capital you need to get started, and you have a wide array of options for financing, all of which are viable. Bank loans are the most traditional way to finance your business, but as with any other type of loan, borrowing from a bank has advantages and disadvantages, all of which you should consider carefully before making your move.

Ownership

When you take out a bank loan, you have complete control over what you do with the money. Unlike other forms of loans and financing, the bank does not assume any sort of ownership or influence in the way you run your business. Nevertheless, paying back the loan also is your responsibility, and failure to do so can result in the bank foreclosing on your business. This is different from equity financing, for example, through which investors take part ownership of your business. In that situation, you are not personally liable if they want to cash out, and it's up to them to find a buyer.

Flexibility

Bank loans offer you access to a wide array of terms, fees, application requirements and interest rates. These variables often differ from bank to bank, and usually can be negotiated and adjusted; you can shop around for the loan terms that best suit you and work with the bank to make the deal as sweet as possible. An issue to keep in mind is that interest rates can rise, making a loan unpalatable or very difficult to pay back. In some cases, interest rates and other terms can change during the repayment period, making the success of your business subject to alterations in the bank's demands.

Application

Banks normally require a lengthy and thorough application process before they will approve you or your business for a loan. Especially in the case of small businesses, which often fail, banks want many details about your business plan before they are confident about loaning you money. This can be a hassle and an obstacle to funding. However, a strong application with a solid business plan and good referrals can make you look very appealing to the bank and win you favorable terms for the repayment of the loan. The application process might even prompt you to address important facets of your business that you hadn't considered previously.

Credit

Credit history is a crucial determining factor for getting a bank loan. Poor credit can pose an obstacle against favorable loan terms or even for securing a loan at all. This is not an issue for other types of funding, such as stock offerings. However, good credit can result in a much higher chance of approval for a loan and favorable terms of repayment. Credit ratings can be repaired and bolstered before approaching a bank for a loan. Even for people with substandard credit, bank loans can be beneficial. Although the terms might be harsh at first, successful repayment of bank loans can be used to build up your credit, making you a more appealing candidate for loans in the future.

References (4)

About the Author

Linda Ray is an award-winning journalist with more than 20 years reporting experience. She's covered business for newspapers and magazines, including the "Greenville News," "Success Magazine" and "American City Business Journals." Ray holds a journalism degree and teaches writing, career development and an FDIC course called "Money Smart."