When taking out a business loan, there are dozens of factors to consider: the loan amount, the interest rate, your projected growth, your current cash flow, the economic state of your industry, etc. Especially for small or medium loans (about $15,000 to $250,000), there can be unexpected fees or penalties that might make the loan end up costing more than you expected.

Securing a business loan can be costly as is, but with less-than-perfect credit, you're looking at higher interest loans that might not be worth the trouble. Here's a look at the factors you should consider when deciding whether to take out a loan despite having bad credit. With the right combination of circumstances, taking out that loan may be well worth the cost.

Where do the numbers come from?

Guarantee fees, servicing fees, origination fees, loan packaging fees...Let's take a look at where the fees and rates associated with a business loan originate.

Lending institutions ultimately exist to make money. And while your business may seem like an obvious slam dunk to you, a financial professional has to take a lot of elements into consideration:

  • Small businesses have higher failure rates and lower access to collateral, making it riskier to lend to them.
  • Small business loans are difficult securitize and sell on the secondary market.
  • Smaller loans can cost a financial institution as much money in transaction costs as larger loans do.

All of these risks need to be offset. And especially in the case of a business or a borrower who has lower credit scores, it's usually higher interest rates and fees that compensate for the higher risk the lender is taking.

When it's worth it

It all comes down to the famous cost/benefit analysis. If you are taking out the loan to invest in a growth opportunity, you need to calculate the best- and worst-case scenarios for that investment and compare that against the true cost of the loan.

(Hint: When looking at more than one loan offer, make sure you're comparing apples to apples by calculating the loan's effective APR.)

For example:

Let's say your apple-selling business has a huge growth opportunity: if you could buy the new apple-picking machine on the market, you would be able to harvest more apples this season. As a result, you expect your sales would increase by $10,000. But you can't afford the machine based on the cash you have available, and you don't have great credit or much collateral. Should you take out a $5,000 loan to cover the cost of the machine?

In the case where your loan is investing in growth, the question will always be whether or not the growth will outpace (or at least eventually outweigh) the effective interest rate.

Can you get an equipment loan, where the equipment becomes the collateral for the loan? This type of secured loan is more comfortable for lenders; if you can't make your payments, they'll just take the equipment back.

However, equipment loans can have interest rates up to 30% for low-credit borrowers, so be careful.

But in our case, that borrowed $5,000 will still only become $6,500 after a year (without monthly payments). And if the loan has no prepayment penalty and therefore allows you to pay it off as soon as you can, then you will still come out $3,500 ahead this season — and now you own an essential piece of equipment outright.

Even with prepayment penalties or origination fees, this is still a good deal for your business, as long as the piece of equipment (or the other growth you're funding with your loan) will pay for itself. Additionally, responsibly paying off this type of loan helps build good credit for your business.

When it's not worth it

For the same apple-selling business, let's say you still need $5,000, but instead of purchasing equipment for a growth opportunity, you need that cash to meet payroll at the end of the season.

In this case, a high-interest loan might simply dig a deeper hole.

With low credit scores and no access to collateral, you might not qualify for an SBA loan, which is longer term and has lower interest rates.

And a non-bank term loan could tide you over for a few months and help you meet your payroll, but to what end? It's just putting a band-aid on your cash flow problem, but with interest rates some times reaching 130% and without adequate revenue coming in, you're just exacerbating the situation.

In this case, the loan is not fixing the reason you got into trouble in the first place, so it will never pay for itself.

The bottom line

When you're in a position of needing funding, always take the time to crunch the numbers, including any potential fees, the APR, the monthly payments, and any risk associated with your investment. You need to know what you will spend, so you can evaluate the true ROI for your business.

High-interest loans, while they can be intimidating, can be worth the price in certain cases. If the loan will, without a doubt, help your business grow and increase revenues, allowing you to cover the cost with a safe margin, it's a worthwhile option. But, if this isn't the case, steer clear.