If it’s your first time considering getting a small business loan, you may be overwhelmed with the process and not know where to begin or how to choose the best loan to fit your business needs. However, by knowing what to expect it can be less daunting because you will know and have everything you need.
What you should do before you apply for a business loan
Before you fill out an application for a business loan, there are a few things to do first before taking the step.
Know your credit score
Your credit score is the most important factor a lender will consider when deciding to approve or deny your loan application. If your credit score is too low, in the 500’s or below, they may deny your application without even considering the rest of your business information. Even if you are still approved with a low credit score, you are at risk for having higher rates, down payment requires, and collateral.
If you have determined that your credit score is too low, you can work on getting a higher score before you apply for a loan. To do this, you must make all your payments on time and begin to start paying down any outstanding debt. You also can keep your credit utilization low (below 30%) and keep credit accounts open.
Lenders look at your personal credit score because this tells them if you are reliable or not when it comes to paying your personal debts. The higher your credit score, the more likely you will qualify for a business loan with the best rates and terms. A score of at least in 600’s or higher are required by many business loans, including banks and the Small Business Administration (SBA).
Know your why and how much you need
After you have determined your personal credit score, the next step is to know exactly how much funding you need and why you need it. Lenders are more likely to approve an application when you can specify why you need funds and exactly how much you need. Your ‘why’ on getting a business loan can be to cover payroll expenses and working capital, financial equipment or machinery, take advantage of a new business opportunity, and more.
Lenders want to know how you will use the funds and that you are going to pay them back without problem. Knowing these two pieces of information are not only beneficial to your planning but also will help lenders determine if whether to approve or deny your loan application.
How much can you afford to borrow?
After you know how much need to borrow, you need to know how much you can afford. In order to determine how much debt you can afford, you can use the debt service coverage ratio (DSCR) to calculate it which is:
Cash Flow / Loan Payment
When your DSCR is greater than one, this indicates that you can afford to borrow the money so lenders look for a DSCR of one or higher. When it’s less than one, this shows that you won’t have the funds to pay the lender back.
Gather the required documents for the application
The next step is to gather the required documents for your loan application. The documentation you need will vary based on the type of you loan you are applying for and your lender however, the following are some examples of the documents you will need when you apply for your business loan for the first time.
- Personal and business information (bank statements, tax returns, credit scores)
- Business plan
- Statement of purpose
- Income statements
- Business financial documents
- Business licenses, legal documents, business permits
- Resume with business experience
- Proof of collateral
How to find the right lender
After you have determined your credit score, figured out how much you need and why, calculated your DSCR, and have gathered all the documentation for the application, it is time to choose the right lender.
The following options are the best options for first-time small business loans:
- Bank loans
- SBA loans
- Lines of credit
- Long-term loans
- Short-term loans
Applying for a business loan
Once you have explored the various options for first-time small business loans, the last step is to finally apply. Remember to be thorough in the application process to avoid any mistakes. The more thorough you are, the faster you will get approved. Be sure to be honest in the process as well, not telling the truth will harm your chances of qualifying in the long run and you will most likely face consequences as well. Note, that even if you do have all the documentation ready to go, there may be some other information that your lender will request of you.