8 red flags banks look for when you’re applying for a business loan

8 red flags banks look for when you’re applying for a business loan

Posted by John P. Bradford // November 21, 2016

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Ive got some good news and some bad news for you regardingbusiness loans.

The good news is that institutional lenders loan approval rates have matched an all-time high at 62.8 percent and small banks have also slightly increased their approval rates.

As for the bad news, the big bank approval rate has dropped to just 23.1 percent. This means that less than a quarter of businesses applying for a loan will receive one.

There are number of outside factors that have influenced these decisions, such as a slowing in global market growth. There are also red flags that keep popping up which banks keep a lookout for whenever a business applies for a loan.

If you are aware of these red flags ahead of time, you can take the appropriate measures to correct them before applying for a loan.

Consider the following eight examples:

1. Bad or nonexistence credit

For banks, a solid credit history is non-negotiable. If you dont have a high business credit score, the chances of obtaining a small business loan from a traditional bank are next-to-none. Even worse,your personal credit score can also prevent you from securing a loan.

In most cases, banks prefer to work with individuals who have a personalcredit scorebetween 680-720, as well as a history of strong money management skills like paying bills on-time. Anything under 680 is a sign to the bank that youre a potential risk.

The good news is that you can repair or build your credit score by establishing a budget, paying your bills on time, keeping your debt low, and reviewing your credit report so that you can resolve any outstanding balances or dispute late payments.

2. Youre not an established business

If youre a first-time business owner, dont be shocked and frustrated when your application is rejected. Its common for banks to prefer established businesses, or least individuals with at least 3 to 5 years of industry experience.

Lenders need to feel confident that youll be able to repay the loan they give you. Thats why credit scores, down payments, and collateral are so important, writes Ian Atkins forFit Small Business. The other piece of the puzzle is industry experience. Lenders need to feel confident that you have the ability to run the business profitably yourself or identify and hire a management team to do it for you.

Without those years of experience, banks will raise serious questions which will need to be allayed if you are going to get the financing you need.

3. Negative cash flow

Lack of cash flow is a bright red flag for banks because it makes them believe that youll pay off your expenses, as opposed to the loan. Even more troubling, theres a trend among lenders where they are examining more frequent periodic payments, such as the daily or weekly direct debits from your business checking account, as opposed to monthly statements. This means a more consistent cash flow is needed to handle these periodic payments.

The good news is that you canimprove your cash flowby taking steps like performing a cash flow analysis, accepting online payments, setting sales goals, and enforcing payment policies.

4. The loan isnt large enough

According to report published by theHarvard Business School, transaction costs to process a $100,000 loan are comparable to a $1 million loan, but with less profit. Because of this, banks are less likely to engage in lending at the smallest dollar level. In fact, there are instances where many banks have either stopped granting lower-amount loans or have reduced the number of that they approve.

eBanks may attempt to refer small business owners to their credit card products, which earn higher yields. In this case, you may be better off looking foralternative loan options.

5. Insufficient collateral

Collateral is a preference for banks because if the business defaults on the loan, the bank can acquire these assets, such as real estate, vehicles, business equipment, or investments and sell them to satisfy the loan. These are called secured loans.

If youre a new business, you probably dont have collateral, so you may have to put a lien on your personal property or search for an unsecured loan. On the flip-side, if youdohave collateral, the bank may not put as much weight on factors like credit history.

6. Lack of preparation

Would you invest in a business without reviewing the business plan, market, or financial projections? I highly doubt that you would consider the investment, nor should you. So put yourself in the banks shoes would you invest or loan to you? If you are walking in asking for money, you need to be prepared to explain what you need the loan for and how youll be able to pay it back.

TheSmall Business Administrationrecommends that in order to be prepared for a loan proposal you need to have the following:

• Credit history

• Loan proposal detailing how much money you need and why

• Business plan and profile. Collateral and financial statements

• Projections

• Legal considerations like articles of incorporation, contracts, and leases

7. Bankruptcy or judgments

If you declared bankruptcy two years ago or had a judgment placed on you within the last twelve months, thats an obvious red flag to a bank that youre a risk and you probably wont be issued the loan, no matter the size.

Fortunately, this is not the end of the world. Yes, it takes time to repair your credit, but if you start working with vendors and suppliers who specialize in customers with poor credit, then its a sign to lenders that youre putting in the effort to improve your credit.

I highly recommend getting a secured credit card where you put down as much as you can on the card so that you get the highest credit limit possible.

8. Your customers are a targeted niche

Dont get me wrong. Having a niche audience definitely has its perks, specifically in a niche market there is less competition, and its easier and cheaper for you to capture a piece of the market. However, having too small of atarget audiencedoesnt really help your business grow. And thats a concern for banks.

Instead of approving loans for businesses with a targeted niche, banks prefer to work with businesses that have a large and diverse market.

Follow these suggestions and get rid of your red flags and go get your loan.

Read more: http://mashable.com/2016/11/16/8-red-flags-banks-look-out-for-business-loans/