6 Factors That Affect Small Business Loan Eligibility
Did you know that some businesses avail of loans with single-digit interest rates while others end up paying hefty interest rates on their small business loans? Your interest rate is determined by many factors including the risk and credit profile of your business. Let us take a look at some of the factors that determine your small business loan eligibility in detail:
- Personal Credit History
If you are new to the business or have never applied for a business loan before, the financial institution will look into your personal credit history to see how you have been managing your other loans and credit card bills if any. The lender will assess the loan repayment history of your existing and past loans. If the borrower has a poor repayment history or they have defaulted on their loan EMIs, the financial institution will turn down their small business loan application. There is also a possibility that a small business owner with bad credibility ends up paying a higher rate of interest on their business loan.
- Select Your Loan Wisely
Different types of business loans come with different terms and conditions. Usually, short-term loans have higher interest rates, whereas long-term loans bear a lower rate of interest. Therefore, one must choose the small business loan term after analysing their business needs.
- Business History
This is one of the most crucial aspects when applying for a small business loan. It can be challenging to get a loan if your business is fairly new or is a start-up. Financial institutions typically consider early age businesses with zero business credit history to be riskier when compared to established ones. If you are a start-up, you may find it difficult to get a lender who would easily finance you. They will either reject your loan application or will lend you at a higher rate of interest. Paying a higher interest rate means you are compensating the financial institution for the risk involved in working with you.
Make sure you bring your business plan with you to show the financial institution how your small business operates and reassure them that they will be repaid. Established firms, like individuals, have credit scores as well. Therefore, work on strengthening your credibility to get a loan at an affordable interest rate.
- Business Financials
Whether you are a new business owner or an established owner, the financial numbers of your business reflect the soundness of your company. Before sanctioning a small business loan, the financial institution evaluates the performance of your business by analysing the profit and loss statement, balance sheet, business cash flows, income tax returns and such. They also look into the sales projection and revenue of the business.
Having a stable business with continuous profit increases the chance of getting a small business loan at an affordable interest rate. Therefore, if you are planning to avail of this loan, make sure you have strong business financials. It is also advisable to pay your income tax dues on time.
- Business Type
Have you ever heard of financial institutions offering a loan to seasonal businesses whose business runs only for 3-4 months a year? Have you ever heard of businesses with risk revenue models getting a small business loan at a lower rate of interest?
Financial institutions usually avoid lending to a borrower who is indulged in a high-risk business. The first and foremost thing lenders look into a business is a steady and sufficient flow of income.
If someone is into a business where he/she makes a profit for six months of a year and has to bear losses for the remaining six months, lenders avoid such types of profiles. Similarly, individuals involved in the business of speculation are also not preferred by financial institutions.
If you are into a start-up or have a new business, your financial institution may ask you to put collateral for securing a small business loan. Usually, when sanctioning the unsecured business loan, financial institutions determine the loan eligibility based on business income, ITR and business credit history. If you are into a new business, your business will lack the aforesaid terms. In such cases, the lender may offer a secured business loan rather than an unsecured business loan.
Collateral may include business assets such as business equipment, real estate, account receivables and outstanding invoices. One may also get a loan after mortgaging their personal assets such as investments and insurance.
For short-tenure loans, lenders usually consider liquid assets as collateral, whereas for long-tenure loans, lenders are likely to accept more illiquid assets. The type of collateral may persuade a financial institution to extend financing to your business since they know they can seize assets if you default.
If you are following and maintaining the above-discussed factors, chances of securing a small business loan are high. So be wise and choose the lender carefully to get the best possible deal for your small business loan.