As your business grows, you may want to pursue opportunities that require more funds than you have on hand. If you are considering applying for financing to close the gap, it is important to understand what lenders look for when evaluating a loan application.
Factors that contribute to loan decisions
How you will use the loan
Lenders want to make sure you’re using the right product for your needs. Options may include small business credit cards, which are designed to help you manage day-to-day expenses; a line of credit, which is used for short-term working capital needs; and a commercial term loan, which is best for financing larger investments over time.
If you’re not sure which type of financing you need, ask your Loan Officer for advice.
Read more: "Is an SBA Loan Right for Your Business"
The amount of financing you’re seeking
Attempting to borrow more than your business can afford is a red flag to lenders. Lenders may also question the application if you don’t borrow enough for your demonstrated need.
Your business and personal credit profile
When you submit your credit application, lenders will typically look at both your business credit and your personal credit standing. A personal guarantee is a legally binding promise to repay money — from your personal assets — that your business has borrowed.
Before you submit a credit application, review both your personal and business credit reports for delinquent accounts (or incorrectly reported delinquencies) with all major credit reporting agencies. Business credit reporting agencies include Dun & Bradstreet, Experian and Equifax; you can check your personal credit reports with Experian, Equifax and TransUnion. If there is any negative information in your credit report, submit an explanation so the lender can better understand the situation.
Read more: “Understanding Your Credit Score”
Your capacity to repay
Your application should also demonstrate your ability to pay back borrowed money. “A lender may ask for at least two years of personal and business tax returns, a debt schedule that includes details of all of your business debts, and personal financial statements,” say top experts in mortgage lending. They add that lenders now might also ask for year-to-date profit-and-loss and balance sheet statements.
You might also need to show business and personal assets, as well as cash reserves. Lenders often want to know about your business’s capital assets such as cash and equipment, and about any funds that others have invested in your business. If you are applying for a loan that is secured by collateral, a lender might ask for details about your accounts receivable, inventory, equipment and commercial real estate.
How to increase approval odds
Gather information before you start
Gathering the necessary information (see common requests below) before you apply can save time and reduce the risk that you will omit anything important.
How much information you’ll need to provide can vary by the type of financing. Credit card decisions usually require a fairly simple application, but loans and lines of credit may require more documentation because of their higher credit limits and longer potential borrowing time span.
Commonly requested data includes:
Information about the business
Name of the business
Business street address and date moved to current address
Business phone number
Business Tax ID number
Nature of the business
Date the business was established
Date the business was acquired by current owner
Number of employees
Annual net profit
Annual gross sales
List of outstanding obligations, if any (include lender, current loan balance or credit limit, and monthly payment)
Two years of business tax returns
Information on collateral, such as accounts receivable, inventory, equipment and commercial real estate
Information about the owners
Your lender may also require the following information about each business owner, guarantor and controlling manager:
Name and title of the person opening the account
Name and address of the entity for the account
Name, date of birth, Social Security number (for U.S. citizens), passport number and country of issuance (for foreign citizens), residential address, country of citizenship, country of residence and percentage of ownership for each beneficial owner and controlling individual (this information is required even if no equity owner has 25% or greater ownership)
Certification that the information provided on the beneficial owner and/or the controlling manager is accurate
Personal household income
Personal financial statement
Two years of personal tax returns
Residence status (rent or own) and monthly housing payment
Work with an advisor
Understanding what lenders look for can help you enhance your application and increase your approval odds. A State Licensed Mortgage Broker can help save thousands over the life of the loan.
Read more: "They Say it's in the Numbers"
How long will it take for your application to be processed?
Each borrower’s situation is different, so time frames for approval and funding may vary. A typical commercial mortgage might take up to 60 days, while a line of credit might take three to four weeks. Credit card approvals may take a week or less. If the lender requests additional documentation, the process might take longer. Your Mortgage Broker can help you navigate many of the forms that lenders require during the mortgage process.
Six Cs of creditworthiness
Lenders look at these six “Cs” to help determine the creditworthiness of a business that’s applying for financing.
Capacity
Lenders will evaluate your business’s financial capacity to support the loan obligation as well as operating expenses. Typically, a business needs to have $1.25 of income to support every $1 of debt service. The extra $0.25 provides a cushion for your business to absorb unexpected expenses or a downturn.
A mortgage lending rule of thumb is that your total monthly home payment should be at or below 28% of your total monthly income before taxes. Lenders may approve you for more or for less depending on your overall financial picture.
Capital
Your business may own capital assets such as cash and equipment that could be used to support your credit application. You and others may have invested funds in the business too, which is also an important consideration for a lender. The amount of capital assets and equity you have on hand will say a lot about your prospects for receiving financing.
A down payment is the amount you pay toward the home yourself. You put a percentage of the home’s value down and borrow the rest through your mortgage loan. A 20% or higher down payment provides the best rates and most options. However, think twice if the down payment drains all your savings.
Low down payment programs are typically more expensive because they may require mortgage insurance or a higher interest rate. Look closely at your total fees, interest rate, and monthly payment when comparing options.
Ask about loan programs such as:
Conventional loans that may offer low down payment options.
FHA, which offers a 3.5% down payment program.
VA, which offers a zero down payment option for qualifying veterans.
USDA, which offers a similar zero down payment program for eligible borrowers in rural areas.
Collateral
Accounts receivable, inventory, cash, equipment and commercial real estate are all forms of collateral — assets lenders may accept to secure loans. When estimating the value of your collateral, a lender will look for liens — existing debt owed — on that collateral. The existence of a lien may disqualify the collateral as a supporting asset for the loan.
Conditions
The state of the economy, industry trends and pending legislation relative to your business are all conditions that are considered by lenders and are factors in the evaluation of your loan application.
Character
Work experience, experience in your industry and personal credit history are all character traits that lenders will consider. Your personal integrity and good standing — and the integrity and standing of those closely tied to the success of the business — are of the utmost importance.
Communication
Your willingness to communicate candidly with your Mortgage Loan Officer and your other advisors about the opportunities and challenges your business faces is key to a productive financial partnership.