Loan underwriting is the process lenders use to determine the risk that a borrower will not repay a loan. A higher risk of non-payment means higher interest rates or denial.
Business Loan Underwriting is a Little Different
When it comes to business loan underwriting, underwriters are looking at the owner’s information as well as information related to the business itself. This is more complicated and usually takes longer.
Here are some common questions about the process, and some tips to make things go as smoothly as possible.
Question #1: What Are Underwriters Looking For?
Loan underwriting is not a game of “gotcha. “ Lenders want to make good loans. After all, that’s how they make a profit. They need to see not only that your business can repay the loan, but that there is a high probability you will repay the loan. They also want to see how you will handle repayment if something unexpected happens. Do you have a plan for making payments if things don’t go as planned?
Underwriters are asking themselves these questions when they review your application. If you know what they’re looking for, you can include all the information needed on the front end.
Each lender has different criteria when it comes to underwriting small business loans. There really isn’t a standard that applies to every lender. Still, generally lenders are looking at the same types of things when they look at your business. But be aware, they may not weigh all factors the same.
How to Answer Question #1 Most Effectively
- Provide all requested information.
- Have financials professionally prepared by an accountant and reviewed by a tax attorney.
- Fill out the application thoroughly and carefully.
Question #2: What Will I Need to Provide to the Underwriter?
Generally, loan underwriting requires you to provide:
- Basic personal information, such as your name, address, and Social Security number
- Your business name or doing business as (DBA) name
- Your Employer Identification Number (EIN)
- A copy of your business plan
- Information about collateral if you’re applying for a secured loan
- Details about your business, including time in business, annual revenues, number of employees, and more
- Financial records, including tax returns, bank statements, and/or pay stubs (both personal and business)
How to Answer Question #2 Most Effectively
Write your business plan long before you apply for a loan. Have a mentor or the local Small Business Development Center help you. Also, gather records requested and review the details for accuracy.
Question #3: How Will the Underwriter Use the Data I Provide?
The data you provide for loan underwriting will be used to do the following.
Verify Business Revenue
If there isn’t enough revenue to support debt payments, you aren’t getting the loan. Most lenders have a ratio that helps them calculate how much they are willing to lend to your business. That is, if they approve the application.
Generally, approval for any amount over 10% of your annual revenues is not likely. This is especially true for traditional lenders. Of course, it depends heavily on whether you have any other business debt.
Verify Personal Credit Score
With traditional lenders, your personal credit score is going to be part of every loan decision. In fact, in some cases it will determine whether or not they will pursue your loan application at all.
Banks generally look for scores in the 700s, though some will go as low as 700. The SBA has a minimum threshold around 650. In contrast, online lenders will go as low as 600 or even 500 in some cases.
If you get approval, the lower your personal credit score, the more expensive the financing. You may also have to provide a personal guarantee or sign off on a UCC blanket lien if your personal credit scores are particularly low.
Not all lenders require collateral, but most banks and the SBA do. While the SBA doesn’t always require that you fully collateralize a loan, they will require any collateral you may have available.
Online lenders will often apply a general lien on business assets. Also, most will require a personal guarantee on small business loans.
Determine Personal Equity in the Business
Underwriters may want to see how much money you have invested in the business. Lenders want you to have some personal skin in the game. If the business defaults, you have something to lose too.
In addition, lenders may use the data to determine a number of ratios that can help them in the decision making process.
Debt Service Coverage Ratio
This is a calculation of your business’ income and the total amount of business financing you already have. It is calculated as Business Income/ Business Debt. If your ratio is below 1.25, it will be difficult to get more financing.
Debt-to-asset Ratio (total debt/ total assets)
This is especially important to underwriting if there isn’t a collateral requirement. It shows whether you have enough assets to cover the loan in the event you default. For example, do you have enough equipment or property to liquidate and cover the loan if you can’t make payments. A ratio of more than 1:1 is favorable.
This only applies if there is a collateral requirement. Lenders really want to see that your collateral is worth at least 20% more than you want to borrow. That’s why you need a down payment of around 20% to buy a new car or purchase a new house. The lender wants to make sure you meet this ratio.
How to Answer Question #3 Most Effectively
Since you now know the formulas often used in the loan underwriting process, you can have your accountant do the math. It doesn’t make any sense to apply if the numbers aren’t in your favor. If you are close, it may be worth a shot.
Running the numbers can also give you an idea of what may be required in terms of a personal guarantee or collateral. This is helpful information to have before you apply.
Question #4: What Are the Dealbreakers?
There are a number of issues that an underwriter may uncover that may can mean “end game” for your loan application. If you know of any of these issues before you apply, definitely disclose them. Knowing ahead of time will allow the underwriters to take note of mitigating factors as they go. If they come across any of these on their own, it is probably game over.
- Recent business cash advances or loans that are discovered but not disclosed in the month to date bank activity
- An excessive amount of negative days in the bank activity printout
- A criminal background history
- Undisclosed tax liens or those not in a payment plan
- A recent bankruptcy (within the last 6 months) or any open bankruptcy
- Unsatisfied excessive or large judgments
- Less than 50% ownership (depending on the lender)
- A major drop in revenue
- Negative landlord references
- An undisclosed default or a restructured business loan or cash advance
How to Answer Question #4 Most Effectively
Check the documents you’re providing and make sure they’re complete. Material omissions, such as new loans that are not yet on record, need to be disclosed.
That way, the loan manager has all of the information and won’t penalize you for omissions.
Data Drives Loan Decisions
You provide the data to lenders that the underwriters use to make the loan decisions. It is imperative that the data you provide is as complete and accurate as possible. If they find inconsistencies, it is very likely they will simply deny the loan.
Something as small as using an ampersand in your business name in one place, and the word “and” in another, can cause enough doubt to deny a loan.
This is why building fundability is so important. Underwriters want to see your business is established as a separate entity from you, the owner. They need to see accurate and consistent information. Consequently, providing this from the beginning will make their job easier and save you a lot of time and frustration.