While not all banks are the same, during the loan review process, many of them concentrate on the same areas. Find out what records, estimates, and stories you’ll need to write, along with advice on how to make sure you bargain for the greatest loan terms.
When you apply for a loan, the bank doesn’t just consider your credit score. They look at a whole range of factors to assess your risk and determine whether you’re a good candidate for the loan. This article will delve into the key factors banks consider when reviewing loan applications, helping you understand what they’re looking for and how you can improve your chances of getting approved.
The 5 Key Factors Banks Consider:
- Credit History: This is a major factor, as it shows your track record of borrowing and repaying debt. Banks want to see a consistent history of on-time payments and responsible credit management.
- Cash Flow History and Projections: Banks want to see that you have a steady income stream and that you’re able to manage your cash flow effectively. They will review your financial statements and may ask for projections to assess your future financial health.
- Collateral: This is any asset you pledge as security for the loan, such as your home or car. Collateral provides the bank with some protection if you default on the loan.
- Character: Banks want to see that you’re a responsible and trustworthy individual. They may consider your work history, education, and community involvement.
- Documentation: Banks require a variety of documentation to support your loan application, including financial statements, tax returns, and business plans.
Understanding Your Credit History:
Your credit history is a detailed record of your borrowing and repayment activity. It includes information such as:
- Credit accounts: This includes credit cards, loans, and lines of credit.
- Payment history: This shows whether you’ve made your payments on time or if you’ve been late.
- Amounts owed: This shows how much debt you currently have.
- Credit inquiries: This shows how often you’ve applied for new credit.
A good credit history shows that you’re a responsible borrower and that you’re likely to repay your debts on time A poor credit history can make it difficult to get approved for a loan or may result in higher interest rates,
Cash Flow: The Lifeblood of Your Business:
Cash flow is the movement of money in and out of your business. It’s essential for your business to have a healthy cash flow to cover its expenses and invest in growth. Banks will review your cash flow history to assess your ability to repay the loan. They may also ask for projections to see how your cash flow is expected to change in the future.
Collateral: Providing Security for Your Loan:
Collateral is an asset that you pledge as security for the loan. The collateral may be seized by the bank in order to cover its losses if you default on the loan. The kind of collateral you provide will determine the interest rate you get and the maximum loan amount.
Character: Building Trust with the Bank:
Character is a subjective factor that banks consider when reviewing loan applications. They want to see that you’re a responsible and trustworthy individual. They may consider your work history, education, and community involvement.
Documentation: Providing Evidence of Your Financial Health:
Banks require a variety of documentation to support your loan application. This may include:
- Financial statements: This shows your business’s financial performance, including its income, expenses, and assets.
- Tax returns: This shows your business’s taxable income and any deductions you’ve claimed.
- Business plans: This outlines your business’s goals and how you plan to achieve them.
By providing complete and accurate documentation, you can help the bank make a more informed decision about your loan application.
Tips to Improve Your Chances of Loan Approval:
- Build a good credit history: Make sure to pay your bills on time and keep your credit utilization low.
- Maintain a healthy cash flow: Manage your expenses carefully and ensure you have a steady income stream.
- Consider offering collateral: This can make you a more attractive borrower and may result in lower interest rates.
- Demonstrate good character: Be honest and upfront with the bank about your financial situation.
- Provide complete and accurate documentation: This will help the bank make a more informed decision about your loan application.
By following these tips, you can increase your chances of getting approved for a loan and securing the financing you need to achieve your business goals.
Improving your cash flow
We advise you to examine the following aspects of your company’s operations if you want to increase your chances of receiving a business loan:
- Pay off, or delay paying, debt. If at all possible, pay off your current debt or refinance it with lower payments over a longer term. For other debts, try to renegotiate payment lengths. Unbelievably, some creditors might overlook some late payments as long as money is coming in. In some circumstances, you might just have to pay your most important creditors first because they are the ones who are providing necessities (like utilities, certain suppliers, payroll, etc.). —and attempt to postpone paying creditors, such as secondary suppliers, who are less likely to force you to close your doors.
- Collect receivables. Try to quickly collect overdue accounts. When a company’s collection policies are not aggressive, revenues are lost. The likelihood that you will get full payment decreases with the length of time your customers’ balance is unpaid.
- Reduce credit allowances and accelerate cash receipts. You can lower the cost of bad debt and increase cash on hand if you can tighten credit terms without alienating loyal customers. Additionally, you can promote cash sales by using pricing and discounting strategies. Additionally, make an effort to shorten the time that customer payment checks float. To accomplish this, you can use a lockbox arrangement with a bank, where you pay a fee to the bank to collect and process all incoming payments, process checks as soon as you receive them, and choose a bank that processes negotiable instruments quickly.
- Increase revenues. Even though every business should strive for this, low cash flow might be a sign that you should carefully consider your options for increasing sales revenues through price adjustments or increased sales volume. When considering strategies to boost sales and improve cash flow, be careful not to approve too many credit purchases. Extending credit will increase your accounts receivable, not your cash.
- Reduce inventory. Your cash outflow should drop if you are able to maintain less inventory.
- Discuss potential cash flow-enhancing tax strategies with your accountant. For example, you may be able to claim a tax credit for employment opportunities you create for certain disadvantaged employees, for costs associated with “qualified research” (research and development), or for the costs associated with property renovation or building rehabilitation of specific qualified buildings. Additionally, you may be able to increase your short-term tax deductions by taking advantage of accelerated depreciation on specific tangible property and equipment.
For more ideas on this subject, see our detailed discussion of improving your cash flow.
Assessing your character as a potential business borrower
The importance placed on a lender’s evaluation of a borrower’s character can differ greatly between lending organizations and between lending officers. Numerous small enterprises have discovered greater success in “selling” their good name and moral character to smaller community banks, which might be more impacted by the local economy.
To ensure youre selling yourself well to your lender, weve compiled the most important steps to follow.
How to Be Successful: 5 Factors That Banks Look For During Your Loan Application
FAQ
How do banks decide who gets a loan?
How does a bank decide how much to lend?
How do banks determine loan approval?
How do banks decide who they are going to loan money to?
How do I get a personal loan?
1. Check whether you qualify for a bank loan 2. Compare rates on bank loans 3. Submit your application for a bank loan 4. Review the loan agreement 5. Receive your funds Banks offer personal loans typically ranging from $1,000 to $100,000. These loans have low interest rates and can come with perks for existing customers.
How does banking and making loans work?
This is not an entirely accurate reflection of how banking and making loans works as this would imply that banks can only lend out the same amount of money that has been deposited with them, which is not the case; banks lend out much more money than customers have deposited with them.
How does a bank lend out more?
In order to lend out more, a bank must secure new deposits by attracting more customers. Without deposits, there would be no loans, or in other words, deposits create loans. Of course, this story of bank lending is usually supplemented by the money multiplier theory that is consistent with what is known as fractional reserve banking .
What should I consider before applying for a bank loan?
They often come with more favorable terms and if the borrower already has an account with the bank lending the money, they may be willing to offer a discount on the interest rate or associated fees. Before applying for a bank loan, consider what you will use the money for.