What You Should Know When You Apply for a Small Business Loan
Obtaining your first loan is a big step for any small business owner. However, the process of applying can seem like quite a challenge if you’ve never gone through it before. Successfully getting financing for your small business requires some preparation. There are a few things that you should be aware of so that you can go through the process without worries.
Understanding Your Small Business Financing Options
Before you start the application process, you should understand what your options are. If you’re sure that you need financing, term loans aren’t the only option available. Small business financing comes in many forms, such as invoice financing or factoring, business credit cards and angel investment.
It’s a good idea to understand the benefits and drawbacks of each so that you can apply for the financing produce that is right for you. Once you’re ready to proceed, you’ll need to have an understanding of your use case and credit, which are two important elements of applying for business financing.
Analyzing Your Credit
Credit history will be the most important element that lenders use when deciding on a loan application. After all, you wouldn’t lend money to someone with a reputation for not paying it back on time and neither do banks. Both your business and personal credit scores will have a strong impact on whether you can obtain a small business loan and under which terms. While there are other factors considered, credit scores are a reflection of your overall financial reputation, which explains why they’re relied on so heavily by lenders.
Your Business Credit Score
When starting a new venture, many small business owners mix their personal and business finances. This can complicate things when filing business taxes or applying for a small business loan. You should establish separate business accounts right from the start to build a credit history for your company and separate your business finances from your personal ones.
As you go along, you begin to build a business credit history, which will translate into a business credit score. The methods used to calculate this score vary from one credit bureau to the other. While Dun & Bradstreet’s PAYDEX score only accounts for your payment history, Equifax and Experian also consider other elements, such as public records, legal filing and accounts in collections. All three of these credit bureaus come up with a three digit score. Even though the ways they calculate it are different, paying all of your bills on time is crucial to maintaining a solid business credit score.
Your Personal Credit Score
Though your business credit score is very important, your personal credit score will also matter a lot in the context of getting a small business loan. Many lenders are reluctant to provide financing to small business owners who have shown to be irresponsible with their personal finances.
Your personal credit score will be determined by a variety of factors, including your payment history. Both the FICO score and VantageScore range from 300 to 850 and are mainly based on how reliable you are with making your payments on time. However, credit utilization also has a big impact on your score.
Utilization measures how much of your revolving credit limits you’ve used. If it’s too high, your credit score will take a hit. This is why it’s better to pay down your credit card balances so that you can achieve a utilization rate of under 10 percent.
Improving Your Credit Scores Before Applying for a Loan
If you want to improve your business and personal credit scores, you’ll first need to see the credit reports that are used to calculate them. There are many providers that let you see your credit reports. For personal reports, you can use Credit Karma and AnnualCreditReport.com. When it comes to business accounts, CreditSignal and Nav are the ones most frequently used.
Although raising your credit scores is something that takes time and patience, there might be certain things you can do to speed things up. These include:
- Checking Your Reports for Errors
Both business and personal credit reports may contain errors that can affect your scores. These could be trade lines that aren’t reported, accounts that don’t belong to you or accounts that you’ve paid off reported as past due. If you spot an error, be sure to quickly report it to the credit bureau.
- Settling Your Tax Liens
If you have any federal or state tax liens, you should contact the relevant agency to set up a payment plan or pay off your entire tax debt at once if you’re able to.
- Paying Off Your Past Due Debts
Past due debts generally gave a negative impact on your credit score. Contact your creditors to find a solution to pay them off quickly. In some cases, you may get a goodwill adjustment that will erase late payments from your report.
In order to boost your credit score in the long term, you’ll have to take on some good financial habits. The best practices include:
- Keeping Balances Low
Generally, you should make an effort to only use up to 30 percent of the total credit available to you. This will show that you’re able to comfortably pay your debts and don’t rely on credit for all of your financial needs.
- Diversifying Your Credit Portfolio
Having a diverse mix of credit account types, such as installment loans, credit cards and mortgages will improve your score, provided that you make your payments on time.
- Signing Up for a Credit Monitoring Service
Credit bureaus now offer monitoring services for a low monthly fee. These will provide you with regular updates of your credit report and show you how your credit score evolves over time.
Making a Specific Request
When you apply for a small business loan, you should make your request as specific as possible. Create a budget for how you’ll use the funds from your loan by estimating what you’ll buy and how much it will cost. If you’re buying equipment, look up its purchase price and other related costs, then project the amount of revenue the equipment will bring your business. Knowing how much you need and what you need it for will make it more likely that you’ll receive a small business loan offer that meets your needs.
Reviewing Your Financial Statements
Your financial statements, including your balance sheet, income statement and cash flow statement, provide some important information about your business. They will help you determine where you’re making money, what your costs and and whether your business is profitable. If it isn’t, you should have a plan in place to turn things around.
Preparing Your Documentation
Requirements vary from one lender to the next, but most will ask you to submit various documents with your small business loan application. These will typically include your complete financial statements, one or two years of tax returns and your accounts payable and receivable. Having these documents ready right at the start can speed up your application.
Understanding the Offer You’ve Received
Based on your credit scores and business financials, lenders will make you an offer that includes a loan amount, an APR and interest rate. The interest rate is the percent of the principal amount that the lender charges you for the loan. The Annual Percentage Rate (APR) gives you a more broad picture of how much you’ll pay for the loan. It includes both the interest rate and any applicable service charges or fees.