Traditional Banks vs. Alternative Lenders: Which Is Better for Business Financing?
Have you heard of the Paycheck Protection Program? This program is part of the recently passed $2.2 trillion stimulus package and is meant to provide relief for small businesses that need extra cash to cover payroll.
The program offers loans up to $10 million to small businesses. These loans are calculated using 250% of your average monthly payroll in 2019. The program is only being offered through SBA authorized lenders.
These loans are eligible to be forgiven if at least 75% of the funding is used to pay workers and if no worker is compensated above $100,000. It’s currently not clear if that maximum includes benefits. Those who can’t get the loan forgiven will have to pay it back in two years at a 0.5% interest rate after six months of interest deferment.
Applications open on Friday, April 3, and close on June 30. The application consists of a two-page form in addition to required documentation.
If you’re interested, be sure to apply at a Paycheck Protection Program authorized lender.
Are you in an area affected by the coronavirus? The U.S. Small Business Administration (SBA) is offering Economic Injury Disaster Loans. If you qualify, you can get up to $2 million and a 3.75% interest rate. You can visit the SBA website or your local SBA office to apply.
The internet has changed a lot about our world, from how we connect with old friends to how we get dinner. And in the world of business financing, the internet has changed how many small-business owners get money.
Banks and credit unions, also known as traditional lenders, aren’t your only financing options anymore. Plenty of alternative lenders, or online lenders, would love to lend to you too. But what makes them different? And how do you know which one is better for you as a borrower?
That’s what we’re here to explain.
Traditional lenders vs. alternative lenders
Typical funding time
Lines of credit
Build your credit
In some cases
Online loan application
In some cases
Traditional lenders: Best for businesses that prioritize low rates
When we talk about traditional lenders, we’re referring to banks and credit unions. They’re “traditional” since they’ve been around basically forever (while you might think of founding fathers as making a nation, they also founded banks), and for much of that time, they were one of the only sources for business loans and lines of credit.
That kind of exclusivity has allowed traditional lenders to be choosy about who they lend to. So traditional bank loans tend to have relatively high application requirements for businesses. For example, a typical traditional lender might look for the following in an applicant:
- A business that’s a few years old
- A very good or exceptional personal credit score (740 or above)
- An annual revenue of at least $250,000
Sure, you’ll find traditional lenders that go soft on one or more of those requirements (for example, some Bank of America business loans require only $100,000 in annual revenue). But generally speaking, you’ll need a healthy, well-established business to qualify for traditional funding options.
So what do you get from bank lending? Well, a low annual percentage rate (APR), for starters. Most traditional loans and lines of credit offer APR starting in the single digits (think 3% to 8%)—often much better than you’d find from alternative lenders.
That means that traditional lenders can save you lots of money on your loan (depending on the loan term).
As an added bonus, banks and credit unions often have other offerings for businesses, like bank accounts, merchant services, and business credit cards. That makes things convenient for you. Plus, some traditional lenders give you discounts when you bundle products (Bank of America, for example, has a Preferred Rewards program).
Just keep in mind that traditional lenders (in addition to their high application requirements) tend to move slower than alternative lenders do. In many cases, you’ll have to apply in person at your lender’s local branch. And funding times will range from weeks to months, rather than hours to days.
Still, if you want low rates on your loans, and you can meet the stricter application requirements, traditional lenders can offer you great deals on business financing.
Alternative lenders: Best for younger businesses that need convenience
Alternative lenders, also called online lenders, are the (relatively) new kids on the business financing block. These non-traditional lenders have been around for only a decade or so—in some cases, just a few years—and they usually offer only financing.
As the name suggests, alternative lenders provide a good option for business owners who can’t qualify for traditional loans. Online lenders often—but not always—have much laxer application requirements. For example, one of our favorite online lenders, Bluevine, has the following requirements:
- A business that’s at least six months old
- A fair or better credit score (530 or above)
- An annual revenue of at least $100,000
Now, those requirements may not be typical of all online lenders. And meeting the bare minimum for each requirement doesn’t guarantee you’ll get approved, and it definitely doesn’t mean you’ll get a great deal on a loan. But as you can see, it’s often much easier to qualify for alternative financing than traditional financing.
And that’s not the only advantage online lenders offer. They also have much faster funding times than traditional lenders do. Kabbage, for example, uses an automated application process that can approve you in just a few minutes and fund you in just a few minutes more. Even slower online lenders will often approve and fund you in just a week or two.
Of course, alternative lenders do have one big downside: higher APR. Starting rates in the double digits are not uncommon. You can almost always find lower starting rates at traditional lenders—if you can qualify.
Lenders express their rates in different ways. (A 5% interest rate is very different than a 5% factor rate, for example.) That’s why we love the SMART Box capital comparison tool. It makes it easier to compare the overall cost of different types of loans and rates.
Also, alternative lenders don’t have the long histories that banks do. The world of alternative lending is still quite young, and things change quickly. If you’re a person who prefers tried-and-true companies with lengthy track records, online lending might not be right for you.
But when it comes down to it, alternative lenders offer more accessibility and convenience to business owners, even if it comes at a higher price.
Browse hundreds of loan options, custom-tailored to your business and budget needs, from a single, simple platform.
What are the best alternative lenders?
Most of our recommended lenders on our list of the best small-business loans are alternative lenders.
As you can see, Lendio is our favorite online source of borrowed capital. You can learn more about what makes it a great lending platform in our Lendio review.
What are the best traditional lenders?
We don’t necessarily recommend any particular traditional lender. We’re pretty wary of most big banks, in large part because many of these large financial institutions have earned bad reputations through less-than-legal practices.
Instead, we recommend you visit your local small bank or credit union. As we mentioned earlier, small banks have higher approval rates than large banks. Plus, business owners who apply for financing at small banks report fewer challenges and higher satisfaction than those who apply with large banks or online lenders.3
How can I increase my chances of getting traditional financing?
If you want to have a better chance of getting a loan from traditional lending, you can do a few things.
First, you can learn how credit scores affect small-business loans and then work to improve your personal credit score. You can also work on building business credit, perhaps by getting and responsibly using a business credit card. Working with vendors and suppliers with payment terms can also help build your credit profile.
Increasing your revenue will also increase your chances of funding, so focus on keeping your business healthy. (It might help to review some small-business bookkeeping basics.)
What types of loans can I get?
Both traditional banking and online lending offer a variety of business loans. You can find everything from term loans to lines of credit to equipment financing to invoice factoring.
Generally speaking, the online lending industry is more likely to offer short-term loans, invoice financing, and merchant cash advances (for things like cash flow, purchasing inventory, and other short-term business needs)—in addition to lines of credit and term loans. Traditional financial institutions stick more to long-term loans, lines of credit, and equipment financing.
Ultimately, whether a traditional lender or an alternative lender is better for you and your business depends on your unique situation.
Choosing your type of lender
Choose a traditional lender if . . .
Choose an alternative lender if . . .
You have strong credit
You have low or bad credit
You want the lowest possible rates
You have a young business
You can wait for funding
You need funding ASAP
Sure, traditional lending gives you lower rates and can potentially save you money, but alternative lending can provide fast financing—even when a traditional lender might turn you down.
Either way, we hope you get the funding you need to build your business.
Before you take out that loan, use our business loan calculator to make sure you understand how much it will really cost.
At Business.org, our research is meant to offer general product and service recommendations. We don't guarantee that our suggestions will work best for each individual or business, so consider your unique needs when choosing products and services.