Contractors, especially those running a small business, often have trouble getting approved for traditional loans because lenders tend to view the construction industry as risky and unpredictable.
When choosing a loan, you should consider the limit and the repayment terms. To understand the cost of borrowing, the most important number is the annual percentage rate (APR), the interest rate annualized for the whole year.
Let’s go over a few of the best options for independent contractor business owners and how you can make an informed choice.
Business Line of Credit
A business line of credit (LOC) is a revolving line you can repay and use repeatedly to fund the growth of your construction company or to cover seasonal cash flow gaps. Basically a line of credit sets the maximum amount that you can borrow at a time. You’ll only pay interest on the credit you use, so a LOC could be a good fit for contractors that need quick cash to cover expenses on a new project with a fast start date (so it can be repaid relatively quickly).
Business LOCs can have relatively low APR, as low as 14%. However, an LOC usually also has a relatively low limit, maxing out at around $100,000. If you need more capital, you’ll need to consider other options.
Traditional lenders, like banks, tend to have the lowest APRs, but also the strictest requirements, often requiring a few years in business and strong revenue. If you’re just starting out, you could turn to an online lender, but they usually have higher APRs and lower credit limits. Bare minimum, you’ll need six months in business and $25,000 in annual revenue to qualify for a business line of credit.
Short Term Loans
Short term loans are appropriate for business owners who need growth capital and have predictable expenses. They’re usually used to make a large immediate purchase for the business, since it’s dispersed as a lump sum and you start paying interest immediately. They usually must be paid off within six to eighteen months.
Short term loans have an APR between 30% and 50% and can range from $100 to $100,000. Usually you’ll need a credit score of at least 500, be in business for more than a year and have annual revenue of at least $100,000.
These loans are best if you need quick capital for a purchase. If you need capital for ongoing expenses, then you’ll be better off with another option.
Also known as account receivable financing, this term describes two options for using invoices to acquire capital.
The first is called invoice factoring, whereby the business sells their accounts receivable to a factoring company in exchange for immediate payment of a portion of the invoice(s). The remainder of the invoice, less a fee, is received when the invoice is paid in full.
The second option is an asset-based loan. These are loans based on the value of outstanding invoices. Essentially, you are borrowing up to 80% against the value of your eligible receivables. The lender will first need to assess the reliability of your customers, so this works best if you work with companies and other reliable customers. These loans typically max out at $100,000 and must be repaid within 6 months.
Equipment financing is a loan used to purchase large equipment that remains functional long-term. The equipment you’re buying is used by the lender as collateral for the loan.
Interest rates for these loans runs between 6-9% and the loans can be up to $500,000 (usually 95% of the cost of the equipment). You will need better credit for this, with a minimum score of about 600 usually being required.
This tends to be used by larger companies. These are very specific loans, made for the purpose of purchasing a specific item or items. Smaller companies should look for a different option.
Small Business Administration loans are backed by the SBA. The SBA can guarantee up to 85% of loans of $150,000 or less and 75% of loans of more than $150,000, with a maximum loan amount of $5 million.
These loans tend to come with very low APRs, running between 5-10%. There’s also a loan packaging fee of a few thousand dollars and an SBA guarantee fee of around 3%, so this loan can be a bit pricey if you’re looking for a short term loan. The loan repayment term depends on how the loan is intended to be used. The longer the repayment, the lower the interest rate.
In order to qualify for an SBA loan, you’ll need a credit score of 680 and provide a down payment of 10-20%. They take a long time to get funded and they’re difficult to qualify for, so small businesses shouldn’t expect access to capital for months, if they’re approved at all.
Taking a loan is always a serious decision that can impact your finances over a long period. The biggest favor you can do yourself is to make sure that you understand everything about your loan and what it will mean for you, your business and your credit. Consider all your options, do your research and make the best decision for you.