How Does a Lender Approve Loans?
Your application is scrutinized by the loan underwriter to determine whether it satisfies the following requirements:
- You’re able or capable of repaying the loan.
Lenders are going to want to know precisely how you plan to pay back the loan. Is your income sufficient to cover the new loan and the existing loan payments after other monthly expenses? Lenders will look at the business’s cash flow (EBITDA, or earnings before interest, taxes, depreciation, and amortization), the DSCR, the timing of the repayment, and the likelihood that the loan will be successfully repaid to determine this. To determine the DSCR, determine EBITDA and divide it by the total annual debt service (add the proposed loan payment to the total of all recurring annual debt payments). A minimum Debt Service Coverage Ratio of 1.20 times is what most lenders look for. EBITDA should, therefore, be at least 120% of the loan payments. Depending on the type of loan being considered, if your DSCR is less than 120%, the loan amount may be reduced or the entire loan may be denied. Tell your lender about any additional income you may have if you want to increase your debt service coverage ratio.
A credit report will be obtained by your lender so they can evaluate your payment history, which is an important step in the loan approval procedure.
- Capital
How much of your own money—in cash or assets—have you put into your business? That is a question your lender will ask. The investment is referred to as capital. In the event that the business fails, your lender anticipates that you will take risks as well. If you have “skin in the game,” the loan underwriter can see that you are committed to seeing the company succeed. The amount of owner capital invested in the company relative to bank debt is calculated by underwriters using a ratio called Debt/Equity. To further hone this ratio, underwriters occasionally use total liabilities, which is comprised of all bank debt plus supplier credit. It is deemed acceptable to have two parts debt and one part equity. Depending on the industry and the borrower’s capacity for cash flow, underwriters may increase that to three parts to one.
- Collateral
The loan underwriter examines the potential sources of repayment. Cash flow generated by the company or piece of property that is receiving financing is the main source. The analysis is conducted using the method described in paragraph number 1 above. The asset(s) pledged as collateral will be sold as part of the secondary source of repayment. The loan underwriter evaluates collateral for quality, marketability, and sufficiency.
- Condition
Before forming an opinion, the loan underwriter will consider additional general factors. These consist of the loan’s intended use, the type of loan requested, and the institution’s policy. Lenders’ appetite for lending to your industry and line of business, as well as regional economic conditions and the overall state of the economy in the nation, will all be taken into account. The loan underwriter, for instance, will need to ascertain whether your industry is expanding, remaining the same, or contracting.
- Character
In deciding whether or not to approve your loan application, your overall impression on the lender will be crucial. The loan underwriter will determine whether you are trustworthy and have the motivation to repay the loan based on your credit history, resume, and/or background information that you provide. They will also determine whether you have what it takes to successfully manage your business through both good and bad times. The qualifications of your key employees as well as your own professional background will be evaluated.
In conclusion, the loan underwriter will take into account each of the aforementioned elements individually in order to form a judgment about whether or not you qualify for a loan. Spend some time gathering and reviewing the required paperwork before submitting an application for a business loan. If you’re feeling overwhelmed, get assistance from a reputable loan packaging business.
