The Basics of Evaluating a Loan Offer

So, you have applied for financing and have received a preapproval or an offer letter but how do you know if that funding option is right for you? Taking out a small business loan is a big decision that should be taken seriously. Today we will go over how to evaluate a loan offer, so you make the best decision for your business.

Understand Your Offer and Terms

The following questions will help you understand your offer and terms for the loan.

  • Is a down payment required? How much?
  • How much are lenders willing to fund you?
  • Is the interest rate fixed or variable?
  • How long will you need to make payments for?
  • Is there an APR rate added on top of the interest rate?
  • Are there late fees?
  • When are payments due?

Shop for Best Rates

Small business owners need to do their research to be fully informed of all the options available. Things to consider are terms, amortization, origination fees, maintenance fees, and more.

Check If You Have an Unsecured or Secured Loan Offer

Knowing if you have an unsecured or secured loan will help you determine what kind of loan you were offered. Ask your lender if you need to provide collateral to be financed. Loans that are secured by collateral have more competitive interest rates and longer repayment windows compared to unsecured loans.

Some lenders will require you to provide a personal guarantee before you are granted funding. Personal guarantees basically mean that if you cannot repay your debt your lender can hold you accountable for the losses.

Research Lender Options

Do your research before working with a lender and make sure they have a good reputation. You do not want do business with someone who have poor reviews and low customer satisfaction. You need to find someone who you can rely on and that you can trust.

You can visit the Better Business Bureau (BBB) and search the lenders by name. The BBB shows you what the company’s rating is with A+ being the best and F the worst. Customer complaints also show up on the BBB.

Ease of Repayment

You should be aware of the ease of repayment when evaluating offers. If possible, be sure to set up auto payments so you make the payments on time and avoid any late fees.

Affording the Loan

You need to determine whether your business can repay the loan. By calculating your debt service coverage ratio (DSCR), you will be able to analyze your ability to repay the loan. DSCR assesses the cash flow you will have to cover the debt and determines how risky your business is.

To calculate your DSCR it is the ratio of your annual debt obligation, including principal, interest, and other fees. The higher your DSCR is, the better because it indicates you have strong cash flow to run your business and have enough to cover new debt.

Another calculation that is considered is debt-to-income ratio (DTI) which measures the relationship between your personal income and debt. In this case, the lower the DTI is the better because it shows how much of your income is designated to debt.

Having decent DSCR and DTI ratios will improve your chances of getting approved. They can also help you determine how much you can borrow and afford to repay every month.

The Bottom Line

Before going through with the loan you are offered, make sure to consider how much you need to borrow. Taking up too much can cause you to pay interest on fund you do not need and too little will require you to seek additional funding. Once you have found the right loan, you can optimize your application and know exactly what lenders are looking for.