The world of small business financing can be a confusing one—especially if you’re just entering it for the first time.
This industry has many acronyms and confusing loan terminology, and if you’ve never shopped for small business loans before, you might feel totally in the dark.
Whether you’re just shopping your options, comparing different loan offers, or signing an agreement, it’s important to know the business loan terms that relate to your financing.
We’re here to clear up some especially confusing loan terminologies so you can be fully equipped to find the right financing for your business.
DSCR stands for debt service coverage ratio—and is sometimes referred to as the debt coverage ratio. Essentially, the debt service coverage ratio shows whether or not a business (on average) has enough cash on hand to cover a loan’s principal, interest, and leases.
EBITDA stands for earnings before interest, tax, depreciation, and amortization. Generally, it’s a measure of a company’s operating performance. It’s a way to evaluate a company’s performance without factoring in tax environments, financing obligations, or accounting decisions.
The LTV ratio (loan-to-value ratio) is a measure of financial risk—comparing the loan amount to the value of the asset that the loan is being used to acquire; in other words, it is calculated by dividing the loan amount by the value of the asset.
A lender is in second position when they’re lending to a borrower that already has business debt on their books. So, if you have a business line of credit out for your business and you go to apply for a short-term loan on top of that, the potential lender offering the short-term loan would be in second position to your current line of credit lender.
A blanket lien is a specific type of lien, but a lien in general is a legal claim written into the fine print of small business loans. They help protect lenders by providing some security in the event a borrower defaults and can’t repay them.
A commercial bridge loan is typically a short-term loan that a borrower can use while waiting for approval for another type of business funding—typically of larger amounts, lower interest rates, and longer times to funding.
APR stands for annual percentage rate. As it relates to small business lending, APR is the annual rate charged for borrowing funds. (In other contexts, APR can be the annual rate that’s earned through an investment.) An APR is expressed as a percentage that represents the actual yearly cost of funds over the term of a loan.
A factor rate is a piece of loan terminology that you might come across when applying to short-term loans or merchant cash advances. It’s a way that a lender can quote the price of the loan—but it’s different from an interest rate or an APR.
A prepayment penalty, sometimes referred to as an early payoff penalty, occurs in the form of a fee when you pay back your loan before your predetermined schedule. Not all lenders utilize this penalty.
Collateral is an asset that acts as security for a loan. If you default on your loan, the lender can take possession of the collateral to liquidate it and recoup their losses. Not all loans require traditional collateral but almost all will be secured in some way.
A personal guarantee is a legal promise that an individual makes in regards to repaying credit issued to a business. If the business cannot repay the debt, the individual will be required to personally repay the loan.
Loan Amortization Schedule
A loan amortization schedule illustrates how a borrower will pay back their loan. It outlines each payment that will occur throughout the life of the loan, helping the borrower understand the specific impact of the loan on their day-to-day budget and on their long-term bottom line.
Fixed Interest Rate
When you have a fixed interest rate, the interest rate you are quoted when you first take out the loan will remain the same throughout the life of the loan.
Adjustable Interest Rate
An adjustable interest rate is mainly used for bank loans and SBA loans. This type of interest rate can fluctuate during the life of the loan and is determined by the market prime rate.
Simple Interest Rate
The simple interest rate, also referred to as a nominal interest rate, is the interest the borrower pays the lender on top of the principal balance.
Lenders charge an origination fee for the processing of paperwork and to verify the information on a loan application. The origination fee may be expressed as a flat fee or as a percentage of the loan amount.
A secured loan refers to a loan that is secured by a personal guarantee or a valuable asset that can be used as collateral, helping mitigate risk for the lender.
Unlike a secured loan, an unsecured loan doesn’t require collateral. Because the lender cannot mitigate their risk with collateral, they may require a personal guarantee or will file a UCC-lien on their business. Typically, unsecured loans have higher interest rates than secured loans.
Sometimes you’ll hear accounts payable referred to as “current liability”. Accounts payable refers to short-term debt that the borrower will need to pay off in the near future.
The term accounts receivable refers to the payments that you’re owed. Essentially, accounts receivable are outstanding invoices.
The Bottom Line
This list of loan terminologies just scrapes the surface of all the different loan jargon out there.
When you’re shopping for a business loan, you could come across many more terms not included in this list. Hopefully, these definitions help you start out on the right foot.
When you come across a term you don’t understand during your loan process, it’s crucial that you take time to dig into what it means and how it affects your business financing. Run a quick internet search, talk to a financial advisor, or consult your accountant. It always pays off to be in the know and read the fine print.