Businesses use loans to cover expenses and fund investments. Loans expand a company’s capacity, but they come with risks for lenders. Small business owners may struggle to make payments and default on their loans. Lenders mitigate risk by establishing small business loan requirements.
Businesses must qualify for a loan before receiving funds. Traditional lenders use these parameters to filter out risky borrowers. Some lenders will welcome riskier enterprises, but they’ll set higher interest rates. We’ll discuss how lenders assess applicants. Knowing how lenders think will help you secure a desirable business loan.
Small Business Loans
What Requirements and Qualifications Do You Need For A Business Loan?
Lenders won’t give business loans to anyone, but they publicize their criteria.
1. Credit Score
Lenders want to know if you can manage the extra debt before giving you a loan. Most lenders look at your credit score to see if you can pay back the loan. Five factors contribute to your credit score, and they all involve your ability to handle debt:
- Payment history: 35%
- Amounts Owed: 30%
- Length of Credit History: 15%
- New Credit: 10%
- Credit Mix: 10%
Most traditional lenders will request your credit score. They will set credit score requirements for obtaining a loan. Most lenders will accept your loan application if you have a good credit score. FICO defines a good credit score as anything between 670 to 739. Here is the breakdown of the five personal credit score categories:
- Poor: 300-579
- Fair: 580-669
- Good: 670-739
- Very Good: 740-799
- Exceptional: 800-850
Lenders will also check your business credit scores. PAYDEX breaks business credit scores into three separate groups:
- Bad: 0-49
- Fair: 50-79
- Good: 80-100
A fair or good credit score gives you a better chance of qualifying for a loan than a bad credit score. It’s understandable for lenders to check your credit score. This score reveals an applicant’s ability to pay debts on time. Some lenders will not ask for your credit score, but their loans have substantially higher interest rates.
Payday loans are some of the most predatory loans in the industry. These lenders don’t ask about your credit score, but they’ll charge APR as high as 600%. Consider raising your credit score before approaching a lender. You can pay off existing debts, use a credit builder loan, or pay every credit card debt before the due date.
2. Age of Business
Lenders feel more confident giving money to an experienced business owner. Business owners with decades of experience have adapted to many economic environments and made many decisions for their companies. Lenders will more happily give their money to this cohort than business owners who launched their startups a month ago. You can also demonstrate your experience as a businessperson if you ran another company or made significant decisions for another company. Lenders want to work with experienced business owners with established companies.
3. Cash Flow and Income
Lenders will only give you a loan if they believe you can pay it back. Your company’s cash flow and income statements provide them with a snapshot of your company’s current health. If your company has generated reliable cash flow and income over several years, highlight that in your application. Lenders want to see consistency instead of one strong year to justify the loan.
Your cash flow and income will determine how much lenders give you. Taking out a loan increases your debt-to-income ratio, making you a greater risk for lenders. Earning more money will increase your loan limit.
Small Business Loans
4. Current Amount of Debt
Your income and debt impact your debt-to-income ratio. Lenders use your current debts to calculate this ratio. They then consider how the new loan will affect your debt-to-income ratio. We’ll use an example to demonstrate how lenders think about your income and debts.
Let’s say a business owner makes $10,000 per month as income. However, the business owner already has debt obligations of $6,000 per month. Their debt-to-income ratio is currently 60%. A loan with a $500/mo repayment raises the debt-to-income ratio to 65%. A higher ratio gives the business owner less room for error, creating more risk for the lender.
Most lenders set debt-to-income requirements for their loans. Having a debt-to-income ratio below 43% will help you qualify for more loans. You can either increase your income or pay off more debts to improve your ratio.
Secured loans require collateral to reduce the lender’s risk. Collateral is an asset that lenders can seize if you don’t pay back the loan. When you take out a mortgage, the house is the collateral. Banks can take ownership of your home if you don’t make monthly payments. Some business loans follow a similar structure with equipment, real estate, or other assets as collateral.
Secured loans have lower interest rates than unsecured ones. If you’re worried about losing collateral, you should not take out the loan. This fear can indicate you are taking on too much debt. You don’t have to worry about losing your assets as long as you pay on time. Borrowers can consider smaller loans to obtain funds while lowering the risk of losing collateral.
6. Business Plan
Business plans help lenders understand where their money is going. These plans indicate a company’s current market position and initiatives to gain additional market share. You may find some or all of the following on a business plan:
- Financial projections
- Competitive analyses
- Growth opportunities
- How the company will allocate the loan’s funds
- Quarterly and annual goals
Some lenders will require a business plan and review it before giving you a loan.
7. Financial and Legal Documents
Lenders have different requirements regarding the necessary financial and legal documents for obtaining a loan. Typically, lenders that ask for more documents offer more attractive interest rates for borrowers. A lender may ask for some or all of the following:
- Bank account statements
- Accounts payable and receivable
- Personal and business tax returns
- Payroll history
- Balance sheet
- Business insurance plans
- Other financial statements
Check a lender’s requirements before submitting an application. After you gather the financial and legal documents for one lender, keep them organized. This approach makes these same documents easy to retrieve if you need to apply for another loan.
Where Can You Get A Business Loan?
Several lenders offer business loans. We’ve compiled a list of choices to consider.
The Small Business Administration backs business loans with competitive terms. SBA loans come with lower down payments and don’t always require collateral. Borrowers receive continued support and business education from the SBA. Borrowers can receive a business loan between $500 and $5.5 million from the SBA.
Banks and Credit Unions
Banks and credit unions offer several types of loans, including business loans. These loans are more challenging to obtain but often come with better terms and rates than the competition. Banks are more stringent about their requirements, while credit unions have less advanced technology and fewer branches.
Online lenders are alternatives to traditional banking. You can qualify for a loan and complete the application from anywhere. Some online lenders, such as Biz2credit, provide superior flexibility and lower rates. Biz2credit offers small business loans and can approve your application within 24 hours. If you need a loan quickly, use Biz2credit’s free form to request a business loan. You can receive funding approval in as little as 24 hours.