The procedures that banks use to evaluate your loan application can seem opaque and confusing, but they’re reasonably straightforward. Whether you’re applying for an SBA loan or looking for a non-SBA bank loan, it’s important to understand what underwriters are focused on.
Every institution has its own underwriting standards, but in every case, they’re sure to consider these five critical factors, listed in order of importance.
1. Debt Service Coverage Ratio
Unsurprisingly, the single most important factor when it comes to bank loan underwriting is your ability to repay the loan. Underwriters pay close attention to your debt service coverage ratio (DSCR, or DCR), which compares your business income and other assets to your total debt burden.
Having a good DSCR is critical to being approved for a loan, and you’ll typically struggle to be approved with any ratio below 1.25. If that’s the case and you’re a new entrepreneur, it may be time to look at other ways to fund your startup.
2. Personal Credit
While establishing your business credit is important, most banks are just as interested in your personal credit when it comes to small business loans. From an underwriter’s perspective, a business owner whose personal finances are in trouble indicates heightened risk for a business loan, even when your personal funds won’t be used for repayment.
Accordingly, it’s important to make sure your personal credit profile is in order when applying for a loan. If your FICO score is below 680, you’ll find it very difficult to be approved. Exceptions can be made — especially if your business demonstrates a very strong financial outlook — but as a rule, you should always try to raise your personal score to at least 680 before applying for a small business loan.
3. Company Net Worth
Evaluating your company’s net worth is one of the first steps to take when deciding whether to apply for a business loan. For your own purposes, it should be pretty easy to subtract your business liabilities from your business assets, yielding your company’s approximate net worth. If you have more liabilities than assets, you’ll find it very difficult to convince a bank to approve your loan request.
While this can seem like a catch-22 if you’re hoping to use the loan to expand your revenue streams, it’s not an ironclad rule. If your company’s net worth is negative but the business itself is strong, you may have a better case to make. This is especially true when you can demonstrate a very healthy level of equity in the business. Alternatively, you can focus on loan products that are usually easier to be approved for, like a term loan.
4. Debt to Asset Ratio
Even in the rare situation when you’re not required to put up additional collateral for a loan, underwriters still want to be sure you have enough assets to repay the funds if you default.
Whether those assets are physical items, such as business equipment or other owned property, or financial assets, like personal bank accounts, the total amount should exceed your total debt burden, which includes any other loans you’ve already taken out. If that ratio falls below 1.0, most underwriters will view your loan as an unacceptable risk.
5. Personal Financial Status
Beyond your personal credit score, underwriters for small business loans want to verify that your overall personal finances are healthy. Ideally, this means you can demonstrate that your personal income is enough to repay the loan if your business fails, or that you have personal assets sufficient to cover that amount.
While overall personal finances are important, they’re not necessarily a deal breaker as long as you’re doing well in the other four categories.