Business borrowing terms explained

We explain the different types of borrowing available to your business

Business Borrowing Terms

Types of borrowing

There are a number of different ways that a business can borrow money. We’ve covered a few of the popular business borrowing terms below.

If a business needs to borrow money on a short term basis, one of the easiest ways to do that is via an overdraft. An agreed overdraft facility means your bank will let you use your current account as normal up to your overdraft limit even though that will mean you have a negative bank balance.

Using a business credit card is another way to borrow money. Credit cards are convenient but they tend to be expensive for anything other than short term funding. Usually, you have a repay a certain percentage of the amount borrowed each month although you can repay more.

A commercial bill can also be used for short-term funding. These can also be described as a bill of exchange.

A business loan is a medium-term form of borrowing. These typically have a term of one to ten years with regular repayments being made until the loan has been repaid.

For longer-term borrowing, you can use a mortgage. Because mortgages can take time to arrange, sometimes a business bridge loan or a caveat loan is used. These are short term loans that provide funds while the longer-term finance is arranged.

If you have a repayment mortgage your repayments include an amount towards repaying the principal which is the amount that you borrowed. If you have an interest-only mortgage the repayments are lower because you only pay the interest throughout the mortgage term, but at the end of the mortgage term, you have to pay back the principal in full.

A convertible loan note is a loan that is convertible into equity. They are generally redeemable as well as convertible.

You can also refinance. This is where new borrowing is used to pay off existing borrowing. A consolidation loan can be used to pay off existing loans and credit cards, and a remortgage can be used to pay off existing mortgages or release equity from a property.

Refinancing is done for a number of reasons. Often it can result in more favourable fees or interest rates, or reduced monthly repayments. It can also be used to switch banks or extend the period of a loan

The borrowing process

When you apply to borrow money, you will have to undergo a credit check. This will determine how creditworthy you are. In turn, this will determine whether a lender is prepared to offer to lend money to you, and if they are, how much they are prepared to lend.

This credit check will examine your credit history. This checks a number of things such as whether you have kept up the repayments on any previous credit that you have had. The credit check will result in a credit rating or credit score. The terms adverse credit and sub-prime are used to describe people with a bad credit history.

The lender may also carry out a stress test. This determines whether the loan is affordable. A number of different methods are used depending on what the borrowing is intended to be used for.

Some forms of borrowing such as overdrafts and credit cards are unsecured. Other forms of borrowing such as mortgages and commercial bills are secured. With a secured loan, the lender secures the loan on your business property or assets. The property or assets used to secure the loan are the security or collateral and if you fail to pay the loan the lender can take possession of them. While the property or assets are being used to secure the loan, they are described as being encumbered assets.

Depending on your credit rating or score, the lender may require a guarantor or personal guarantees. If someone agrees to become a guarantor or signs a personal guarantee they become responsible for the repayment of the loan in the event that the borrower fails to make any repayments.

As part of your application, you may have to pay an arrangement fee to the lender and if you are using a broker you may also have to pay a broker fee.

Interest

Interest is the amount you have to pay to the lender to make it worth their while lending the money to you. It is calculated as a percentage of the amount you are borrowing. It can take the form of a fixed interest rate which stays the same throughout the loan term or a variable interest rate which can change.

Variable interest rates are calculated in a number of different ways. Some are tied to the BBR or the Bank of England Bank Rate. This rate is set each month by the Bank of England. Others may be tied to the LIBOR which is the London InterBank Offered Rate. This is the interest rate that lenders use when they borrow and lend money to each other.

Some lenders use their own SVR or Standard Variable Rate to calculate the interest. This is not tied the to the BBR or LIBOR but will follow it those interest rates fairly closely.

A tracker mortgage is a mortgage which tracks one of these interest rates. Sometimes these will take the form of a capped rate mortgage where the interest rate will fluctuate but there will be a maximum interest rate that cannot be exceeded no matter what happens to the interest rate that it is tracking.

Lenders may also offer a discounted rate mortgage. The discount applies to an introductory period after which the interest rate reverts to a higher rate. This higher interest rate is called the reversion rate. The introductory period usually lasts between two and five years.

Lenders calculate interest rates differently depending on the type of borrowing. For short term borrowing, interest can be calculated on a daily basis, whereas for other types of borrowing it might be calculated on a monthly or yearly basis. This means that although two lenders might both be quoting the same interest rate in percentage terms, the actual amount of interest they would charge could be different.

To address this, lenders have to quote an APR or Annual Percentage Rate. This shows you the true cost of borrowing over a year, including any fees that will be charged, and enables you to compare different borrowing options.