Are you looking to take out a loan to scale your business?
Or do you need to buy new equipment like trucks, cars, or electronic devices?
No matter the business loan purpose, there are many ways to fund a business, including using your own savings, invoice financing, peer-to-peer lending, and more.
But if you’re considering applying for a business loan, then this will be one of the most important posts you’ll read today.
And here’s why:
When applying for a business loan, you must understand the factors lenders look at before approving your loan.
Knowing these key points will drastically increase your chances of approval.
In the next few minutes, as a financial coach and banking expert with over two decades of experience, I’ll reveal the most important factors you should look at, prepare for, or improve on so that you’ll never face a loan denial again.
Factors Lenders Look at When Considering Your Loan Application
Applying for a loan can be tough and stressful for many small businesses. You may need the funds quickly to avoid cash flow troubles, or the funding will play a crucial role in growing your business.
However, no one wants to waste their time and resources applying for a business loan that has no guarantee of being approved.
Knowing how banks and lenders think when assessing your creditworthiness and loan application can massively increase your chances of getting that loan.
That’s why I’m here to show you the factors lenders look at when considering your loan application:
Credit (Business and Personal)
When taking out a business plan, most lenders will use your credit scores as one of the biggest factors when deciding whether to approve your application.
A higher credit score can help qualify you for the best financial products out there, such as a business loan.
A high credit score tells lenders you are capable and responsible enough to repay the loan.
But what is considered a bad and good credit score?
Here’s a quick look at credit score ranges by the two most used scoring models:
FICO Credit Score Range
- Exceptional: 800+
- Very good: 740-799
- Good: 670-739
- Fair: 580-669
- Poor: Less than 580
VantageScore Credit Score Range
- Excellent: 781-850
- Good: 661-780
- Fair: 601-660
- Poor: 500-600
- Very poor: 300-499
Here are a few tips on how to improve your credit scores:
- Consistently pay on time
- Lower Credit Utilization Ratio
- Get a Secured Credit Card
- Get a Credit Builder Loan
- Don’t open multiple accounts at once
- Ask for a credit limit
Repayment Capacity
Lenders, banks, and other financial institutions want to know that you can complete the repayment for the loan.
When you apply for a business loan, you give authority to your lender to check your bank statements, credit history, and last year’s ITR to be able to evaluate your repayment capacity.
Cash Flow and Income
Lenders will also take a look at your business’s cash flow since it can also help them determine your capability to repay the loan.
A positive cash flow can massively increase your chances of a loan approval.
Lenders also want to know if you have a consistent income.
Income requirements typically depend on the loan amount.
Lenders would like to see a higher income so that they are more confident that you’ll meet every debt.
Collateral
If you’re taking out a secured loan, you’ll need to offer collateral.
Offering collateral like real estate, vehicle, or equipment can help improve your loan approval since it lessens the lender’s risk.
Collateral is a valued item that you’ll pledge to give up if you can’t repay the loan.
Collateral is more crucial than you think since the value of your collateral will also determine how much funds you can borrow.
In most secured loans, however, the item you’re purchasing is usually the collateral.
For instance, if you take out an auto loan to buy a car, the car you bought will serve as collateral if you can’t complete the loan repayment.
Debt-to-Income Ratio
Your debt-to-income ratio is the comparison of your monthly debt to your income.
A lower debt-to-income ratio can show that you have more available profit to repay new debt, which boosts your chances of loan approval.
Generally, your DTI helps lenders see your overall financial health.
Business Plan
Of course, when applying for a business loan, you should never forget your business plan.
A strong, well-organized business plan is a blueprint for success.
Your business plan should indicate all your plans for the business, like how are you going to use the money, how will you be able to repay the loan, and more.
When a lender reads your business plan, they should have a clear vision of what your strategies are for growing your business.
Here are a few crucial points that your business plan should have:
- Executive Summary
- Company Description
- Products and Services
- Market Analysis
- Organization and management
- Product line
- SWOT Analysis (strengths, weaknesses, opportunities, and threats)
- Marketing and Sales Strategy
- Funding Request
- Financial Analysis
- Appendix
Loan term
Lastly, lenders and banks also look at the loan terms.
Your financial health might be good over the last two years, but we won’t know for sure if it’s still the same over the course of 10 or more years.
Sometimes, entrepreneurs take a big financial crisis, and that’s why lenders typically want a much shorter loan term since you’re more likely to repay the loan shortly.
Borrowers can also benefit from a shorter loan term since they’ll only have to pay interest in just a few years.
What Lenders Look for in Your Business Loan Application: Summary
Understanding how lenders evaluate your loan applications can help increase your probability of loan approval or even tell you what went wrong the last time you applied.
For instance, if you think your credit score is too low at the moment, maybe it’s best to build it first before applying for a new loan.
This doesn’t just boost your chances of being approved, but it can also open up various financial products with lower interest and flexible terms.
Lenders will also look at your repayment capacity, cash flow, income, debt-to-income ratio, collateral, business plan, and loan terms.
So, before sending out your application, try and check these things first.
Applying for some loans will take a longer time.
If you value your time like I do, check these key factors first before sending out your application as it can speed up your loan approval process.