The percentage of total bank business loans that go to small business is in decline over the past few years. Today, it is harder than ever for a small business to get a bank loan, but it is not impossible. Today, we will discuss the primary hurdles you may encounter when trying to get a bank loan for your business and how to overcome them.
Knowing how much to ask for
Banks have a formula for determining how much money they will lend to your business. This formal is known as the debt service ratio. It is crucial that you know your debt service ratio before you go into the bank and ask for a loan, and it will make it more likely that you will be approved for the loan.
To calculate your debt service ratio, use the following formula:
- Debt Service Ratio = Monthly Free Cash Flow / Monthly Loan Payment
Money that is left over from each month when all expenses are paid is your monthly free cash flow. Banks are unlikely to make a loan where the debt service ratio is less than 1.25 so you want to make sure that you have a ratio of 1.25 or higher.
Before you ask for loan, figure out how much the bank is likely to lend to you based on your debt to service ratio. Small business commercial loans have rates somewhere between 8 to 13%. Keep in mind that banks will not lend to companies with less than two years of operating history. If this is your case, consider another method of obtaining money such as a personal P2P loans or ROBS.
Your personal credit score
To borrow money from a bank, small business owners will need to sign a personal guarantee. A personal guarantee states that if the business is not able to pay the loan, they are personally liable. This means the bank is likely to place as much emphasis on your personal credit score as they are the creditworthiness of your business.
Before going and asking for a loan, make sure that your personal credit score is 700 or higher. If you find that your score is lower than that, the following steps will help you improve:
- Dispute any errors on your credit report
- Keep your debt to credit ratio below 30%
- Pay off your cards that have small balances and just use only one primary card
- Pay your bills on time
Collateral for the loan
Banks are going to want collateral for the loan, even if you have a good debt to service ratio and personal credit score. Not only are they going to want collateral, but they want the right type of collateral.
If you do not have the right type of collateral, focus on getting a Small Business Administration (SBA) loan. SBA loans are commercial loans that are backed by the SBA. Because the SBA will pay some or all of the loan if you are not able to, lenders are willing to make SBA loans to borrowers without collateral. You still need to be in business for at least 2 years, have a good debt service ratio and a good personal credit score. In case you do not meet your loan obligations, the bank will sell off your collateral to cover their expenses.
Lack of preparation
Lack of preparation can amount to several different things when you are trying to get a bank loan. The major two are the following:
- Not filling out the application correctly: this could be that you did not fill it out completely or because did not fill it out truthfully.
- Knowing how much to ask for: avoid not asking for enough or asking for too much.
To be sure that you are prepared for the loan process so do enough research so that you know you are ready and fill out the form entirely.
The Bottom Line
Although it is now difficult to get bank loans than it was several years ago, it is still possible to get approved. Knowing the hurdles, you will encounter will help you prepare yourself so that you increase your chances of receiving funding for your small business.