If you are considering taking out a small business loan, you have to put together a foolproof business plan, complete with all the documentation necessary to reassure the bank that you are a good risk. But even before you do that, you should understand what a lender looks for in a potential customer. One way to do this is to view the loan from the lender’s perspective. Here are some questions a lender asks before giving out a loan.
Can You Pay the Small Business Loan Back?
One of the first things a lender considers is whether you are capable of repaying the loan. One tool they use to determine this is the Debt-Service Coverage Ratio (DSCR). The DSCR compares the money you have on hand to the money you want to borrow annually, including interest. Banks prefer that a business has a proven success rate over a number of years before they loan out money, so if your business is a startup or your profits have been marginal, you will have to provide a detailed plan for how you’re going to repay the loan.
Will You Pay the Small Business Loan Back?
Lenders also ask if you actually will pay the loan back. Just because you can repay a loan doesn’t always mean you will. To get a feel for this, lenders look at your personal credit score, which is a good measure of how you handle money. They also look at is your debt to income ratio, which is your total monthly debt divided by your gross monthly income. Most lenders prefer a ratio of less than 36 percent. If you have a not so great DSCR but a good debt to income ratio, this can sometimes sway a decision in your favor.
Another question lenders will ask someone applying for a small business loan is what you’ll do if something happens and you can’t pay the loan back. Even the most thorough plan can hit a glitch. Most banks want to be confident that you have more than one option for paying back the loan. For example, you should have a source of extra cash if at all possible, and you should be prepared to put up collateral such as your house or car. If you don’t have more than one source for repayment, you may want to rethink getting the loan at all.
Think over each of these questions. See them from the bank’s point of view. Knowing what the lender considers will help you be better prepared if and when you decide to seek out a small business loan.