The need for funding will always arise in any business. Loans are necessary for giving the company a boost, handling emergencies, taking advantage of investment opportunities, and filling budget deficits.
But qualifying for a business loan is not easy. Just as you exercise caution in investing your money in the best money market accounts, lenders are keen on ensuring that the money that goes out, comes back with interest.
They place strict restrictions that result in numerous loan application rejections, especially for startups and small businesses.
But knowing the issues they are keen on increasing your chances of getting the money you need. And understanding the alternatives ensures that a bank loan rejection is not the end of the road for your business.
Let’s look at the factors that influence lenders when deciding if your business qualifies for a loan or not.
1) The Amount You Have To Put Down
If you are applying for a loan to purchase an asset or carry out a project, a question most lenders will ask is the percentage of the project or cost of the asset you will be financing. It is especially a requirement when the collateral is not sufficient, or your credit rating is low.
A few other reasons determine if a bank will require a down payment for your loan:
- The lender’s lending policy
- The amount of loan applied
- The reasons for applying for the loan
- The type of loan you have applied
Although not all lenders ask you to put down some money, doing it helps your case. It is an indication of your commitment to the project. People who make a down payment are less likely to default. For this reason, your loan will have a higher chance of getting approval.
Another reason most lenders prefer lending to borrowers who make a down payment is the ease of disposing of the collateral. Should a default occur, the lender can sell the asset at less than top dollar, and adequately recover their money.
It will also benefit your business in reducing the amount borrowed, which reduces the loan interest expense. Your monthly installments and debt burden on your business will be lower.
Whether a down payment is a requirement from your lender or not, always try to put down some money.
2) Credit History
The credit history of your business affects your ability to get loan approval. It can hurt or increase your chances of being successful with your application. The lender will look at the length of time you have been borrowing, your borrowing patterns, and repayments.
If you have a history of bankruptcy, default, late repayments, or missed installments, it kills your chances of getting the funds you need.
On the other hand, if you have borrowed different types of loans and completed your repayments without problems, the lender will be eager to lend to you. They assume that you will make the same timely repayments with future loans.
For a small business loan, the lender will not just look at the credit history of your business, but also your personal credit history as the guarantor of the business loan. They need to check your creditworthiness, which is summarized in the credit score.
Your credit history accounts for 35% of your FICO score, which is one of the major credit scores used by lenders. You cannot erase your bad history as a borrower overnight, but you can take steps to improve it. As you work towards building your credit, your credit score will also improve.
Here are a few steps you can take:
- Make timely payments of your bills
- If your suppliers do not share your positive payment experiences with business credit-reporting agencies, add the trade references manually
- Ensure that debt collection agencies delete negative accounts upon payment
- Maintain low balances
3) Work History
Getting a business loan using your company may fail, especially for new and small businesses. Most lenders will finance a business that has been in operation for at least two years, and that has a good credit score.
If your business does not qualify for a loan, you can apply for a personal loan and use it to finance your business. Besides your credit score and level of income, the lender will pay attention to your work history.
Your work history will indicate the stability of your income. It will show the likelihood of losing your job, and consequently defaulting on your loan payment.
If you have changed jobs in the last one or two years, lenders take this as a red flag. If you have had a salary raise in the recent past, the lender will use the salary you have been earning for the last two years as the criteria for qualifying you for a loan.
If you are acting as a personal guarantor for a business loan, your work history will also play a part in influencing the lender’s decision to approve or reject the loan. As a guarantor, it becomes your obligation to pay back the loan in case the business fails. For this reason, the lender needs to be sure of your capability.
4) Debt-To-Income Ratio
Business financial ratios are essential tools in determining how well a business is performing financially. A critical ratio that influences a lender’s decision to approve funding is the debt-to-income ratio (DTI).
The DTI is a measurement of your businesses’ total monthly recurring debt payments to its monthly gross income or sales. It is in the form of a percentage. If the monthly recurring debt repayments amount to $12,000, for instance, and the monthly gross income is $80,000, the debt to income ratio will be 15%.
What accounts as recurring debt is any payment that the business has to pay without fail. They include loans, minimum credit card payments, and asset finance loan payments. Monthly bills do not count as recurring debt payments because you can easily terminate them.
Maintaining a ratio of 40% or less keeps you at a safe side. It shows the lender that you are capable of taking on another monthly loan repayment without defaulting.
This ratio does not just help a lender in assessing your business for loan approval. It keeps you from taking more loan obligations than the company can handle. Over-borrowing can paralyze your business.
5) The Types of Loans
The type of loan you are applying for will also determine if you qualify or not. As a small business owner or startup, applying for large loans requires a high credit score, collateral, guarantors, significant cash flow, and a down payment, which can prove to be difficult.
However, banks and credit unions are not the only lenders in the market. Numerous non-traditional lending institutions are emerging. They offer friendlier terms, quicker disbursement, and a higher approval rate.
Your chances of qualifying for a non-bank loan are higher.
Explore and research the alternative lenders in the market. Whether you are seeking additional capital or funds to boost your cash flow, you can always find a lender who offers the type of loan you need. Here are some examples:
- Peer-to-peer lenders
- Business-to business lending
- Merchant Cash Advances
- Reward-based crowdfunding
- Equity-based crowdfunding
- Invoice financing
Qualifying for a business loan is not a walk in the park. Banks are keen on the business’s ability to pay and will look at its credit history, contribution, level of debt obligation, and the income stability of the guarantor.
The type of loan you are applying for will also determine your chances of getting an approval. With alternative lenders, the approval rate is higher. And if traditional or non-traditional business loans do not appeal to you, you can always use a personal loan to finance the company.
Thomas Cappetto is the director of public relations at Crediful, your guide to everything personal finance. When he is not fine-tuning communication within Crediful and connecting with other blogs, he enjoys long walks on the beach with his wife Shelly and their two sons Johnathan and Alexander.