How to Avoid Hidden Loan Costs
Do your homework before signing on the dotted line.

By Larry Lee

Many banks are offering small business loans at excellent rates. However, some of the deals that seem too good to be true often have hidden charges that can make the loan costs much higher than you might expect. By knowing about these hidden charges, you can avoid them and get a loan that is economical and fair.

Many loans have costs that are not apparent unless you read and ask questions. Some of these costs include bank charges, balloon payments, loan protection insurance, and covenants, closing costs, commissions and annual fees.

Do Your Homework
The way to avoid misunderstandings and "buyer's remorse" is to thoroughly do your homework. If you are currently in business, you already have spent a lot of time figuring out the issues of your business. If you are just starting your business, you probably have spent considerable time researching the viability of your business concept or model. Use the same careful research when applying for a loan.

Borrowing money to buy a business, finance assets or obtain additional working capital is vital to your business. But be sure to ask lots of questions. You need to feel comfortable with the loan terms and conditions. Make sure you understand your annual percentage rate, the amount of your monthly payments and how long you will pay them. Remember, the laws pertaining to commercial loans are different than "consumer" loans, such as when buying an automobile. Contact the U.S. Small Business Administration for referrals to reputable lenders.

Before you even start filling out loan applications, gather your personal financial information and fill out a personal financial statement. The smaller the business, the more closely the owner(s) will be evaluated. Small businesses with the legal structure of sole proprietorship or partnership are closely tied to the overall experience and character of the owner or owners. Consequently, personal financial records must be in order before asking for a loan.

A solid personal credit rating also is important because the small business is typically an extension of the individual starting it. Get your credit report (with credit scores) from at least one of the three major credit-reporting agencies. When you have a solid understanding of where you are ranked, you stand a better chance of getting the best interest rate and not becoming prey to unscrupulous lenders.

When applying for a loan, you'll probably need articles of incorporation, taxpayer ID number, legal descriptions of real property, copies of all leases, equipment inventories with serial numbers and proof of insurance for collateralized items.

Seek Legal Advice
Always have your lawyer review your loan documents before you sign them. This is especially important if you lack experience in the process of obtaining a loan. If a lender makes an effort to talk you out of having your attorney look over the documents, find another bank. Read every word in the loan agreement before you sign it. Don't let anyone rush you. During the loan signing process, regard every document you sign as a binding contract. Never sign anything that you have not read in its entirety. And do not, under any circumstances, sign a blank document or a document with empty lines that could be filled in later.

Shop Around
Don't feel pressured to sign a loan agreement with the first banker who approves you. Shop around and compare interest rates, terms, covenants and other costs, just as you would with any other important shopping decision.
 Balloon payments are large, lump-sum payments scheduled at the end of a series of considerably smaller periodic payments. They may be acceptable in some situations, but usually they are detrimental for most small businesses. Loans with balloon payments usually come back to haunt you later.

If your business is flourishing, and you have the funds to pay down your loan more quickly, that can save you interest expense. But if your loan agreement contains a prepayment penalty clause, you may end up paying significantly more than the original loan amount. Some lenders will include prepayment penalties to prevent you from refinancing a high-interest loan. Currently, SBA 7(a) loans may be repaid without penalty.

It may not be an advantage to refinance your loan at a lower interest rate. Determine precisely what fees and other charges will be assessed. Some unprincipled lenders offer low initial rates and hit you with big fees after you sign the loan agreement.

Remember to be aware of and avoid possible hidden charges to find a loan that is economical and fair.

Larry Lee is the director of the UMKC Enterprise Development Laboratory at the Institute for Entrepreneurship and Innovation. He is a former commercial lender. You can reach him at (816) 235-6429