What Do Lenders Look for When Evaluating Your Loan Application?

Perhaps you’re trying to get a small business loan because you want to open a new location or purchase new equipment. Maybe your business is going through financial constraints, or maybe you just need a buffer during a slow season. Either way, applying for a loan can be a stressful process. You know that once you apply, you’ll need to go through an evaluation, so you want to put your best foot forward.

Unfortunately, not all businesses get approved for a loan because they don’t meet the lenders’ requirements. To increase your chances, it’s good to know what factors lenders take into consideration when making their decision. No business owner wants to waste time and resources applying for loans they’re not likely to receive.

Of course, not all lenders are the same. They can be banks, microfinance institutions, private lenders, or crowdfunding sites. Still, they all essentially want the same thing: reassurance that you will repay your loan plus interest on time.

Credit History

When you apply for a loan, lenders will want to review your business credit history, and since a personal guarantee is often also needed, your personal credit history as well. If they see that you have trouble paying your own debts such as student loans, credit cards, mortgage, bills and car payments – it can be a red flag because lenders will feel less confident about your ability to pay your business loans. A personal credit score below 680 is deemed subprime and can cause problems when trying to access business loans.

Suppose your business is not a start-up and has been in existence for a while. In that case, lenders will also want to evaluate its payment record, how much debt you’re carrying, credit accounts, credit inquiries and any history of defaulting on payments or bankruptcy. If you’ve been operating without any form of credit by using your personal assets, you should make some trade purchases since most lenders will expect at least four or five in order to establish a company’s creditworthiness.

We recommend that you request and review your credit report and that of your business before applying. This way, you can see if there are any inaccuracies and correct them before they can damage your chances of getting approved. Credit agencies are obligated to remove any information that can’t be verified or that has been proved inaccurate from their reports. If your credit report does have some problems which are not inaccurate, you can also request to add positive credit history with other creditors that hasn’t been included to offset it.

Your Business Financial Standing

Lenders will also evaluate your business’s financial health by reviewing

s documents such as income statements, balance sheets, projected income statements and balance sheets, tax returns, cash flow, and business plans. There are several solutions for lenders to help them gain insight into your company’s financial position. Cash flow is one of the strongest factors taken into consideration when you’re applying for a business loan because lenders want to see if you’d actually be making more money after you get approved and if you’ll have the ability to pay them back. It will also validate your claims in regards to how you’re planning to use the funds.

This might seem counterintuitive because the reasons you’re asking for a loan might be precisely because you need additional funds to stay afloat, but you send in your application, you need to do everything you can show your business is financially stable by reducing unnecessary expenses.

Collateral

When you’re applying for a business loan, many lenders will require you to secure the loan through collateral as a way for them to minimize the risks they incur by extending credit. The collateral will usually be an asset such as real estate or equipment that the lender can sell if you default on the loan payments. The collateral you provide to secure the loan has to match or exceed the amount of money you’re asking for.

This relationship between the value of the collateral and the amount you wish to borrow is called the loan-to-value ratio, and it’s influenced by several factors. For example, if the real estate you offer as collateral is occupied, lenders will usually provide a loan that covers 75% of its appraised value. If it’s vacant but improved, you might get 50%. For vacant and unimproved properties, you can expect 30%.

Many lenders will also want to make sure there are no prior or superior liens to the collateral since, as the priority lien, they can get their share of the foreclosure proceeds before any other claimant. Therefore, they’ll check public records for any prior claims. If the collateral you provide is in the form of real estate, this verification is done through a title insurance company. Any fees incurred during this process will usually be passed on to you as part of the loan closing costs.

You can also opt for an unsecured loan but keep in mind that this means you need to have a very stable business and a high credit score. With collateral, you can get your application approved much faster.

Debt-to-Income Ratio

Your debt-to-income ratio will also be taken into account when evaluating the creditworthiness of your business. You can calculate this ratio yourself by dividing the total of your monthly obligations by the total monthly income. The lower the ratio, the better your chances. I should not exceed 36.

If you have a high debt-to-income ratio, it means that there’s a high risk you won’t be able to repay the loan, and it’s a red flag for lenders. Again, you’ll want to make sure you clear as much of your debt as possible before you apply. Lenders usually prefer businesses that can generate an income of at least 20% higher than the total debt burden.

Application History

Shopping around for a personal loan is usually seen as normal, but it’s not the same with business loans. Since lenders are usually flooded with requests, when they check your record, and they see a lot of credit checks from other lenders, they can interpret it as a red flag since it might mean that the previous lenders rejected your applications because of irregularities they found in your documents.

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