One of the most important factors that lenders consider when deciding to approve you for a loan is that they want to ensure that the loan will be repaid on time. No matter what kind of debt you have, personal or business, they can both affect your application for a business loan.
We will first start with the discussion of the types of business debt, secured and unsecured. Secured debt includes term loans, debt service coverage ratio, revolving debt, and unsecured debt.
- Term loans: loans that are backed by collateral are secured and if the borrower defaults, the lender can seize and sell the assets.
- Debt service coverage ratio: this metric is calculated by banks to measure the company’s ability to pay all of its debt obligations out of its operating income.
- Revolving debt: a type of secured revolving debt are loans used to finance inventory and receivables. When these are used as collateral for revolving debt, they cannot be used to secure another loan.
- Unsecured debt: banks require a healthy debt to equity ratio and balance sheet for unsecured loans.
Lenders will review your personal credit history and credit score when you apply for a loan. Having a strong credit history and high score will increase your chances of getting a business loan so make sure to strengthen your status in order to improve your chance of getting approved for a business loan.
- Mortgages: lenders will look at your personal debt service coverage ratio which is the ratio of your fixed debt payments to your income. Mortgages are high in monthly payments and if it is high in relation to your income then lenders will not feel comfortable lending to you.
- Credit cards: lenders also want to see how you manage and use your credit cards. If they see you have a lot of debt and high payments, they will be reluctant to give you the funds.
- Student loans: if you have student loans, it can improve your credit score by making on time payments.
- Auto loans: similarly to a mortgage, auto loans are secured installment loans. There are a set number of payments over an agreed upon period of time. If you default on the payments, the lender can take your car and sell it to get their money back.
What Is Bad Debt?
Depending on the situation, the debt can be either good or bad. The following are examples of each that could potentially fit into that category:
- Has a high interest rate
- Has a long term
- Purchasing an item that loses value
- Has a low interest rate
- Increases your net worth
- Purchase an asset that gains value
- Is an investment towards your future
- Has a term that lets you pay off the loan quickly
The Bottom Line
Both business and personal debt are opportunities to show that your company is in good standing for the potential lenders. It is important to understand both types of debt and how they affect applications for business loans. By understanding the types of debt, you can work on improving your chances of getting approved for a loan.