I’m a former Vice-President and Relationship Manager of a large international bank, and in my lifetime of reviewing loan applications I have found that most business owners are in the dark when it comes to understanding how banks make business lending credit decisions.
Yet the answer is surprisingly simple. They want to be 99.5% sure that they will get paid back in full and on time. A bank typically only makes 3.4-3.75% on the money they lend your business. They have to pay depositors, other banks, or the federal government some percentage annually for the use of the money they lend to you.
All but the largest banks price their loans by taking the interest they pay to borrow the money they are going to loan to you, and add 3.4-3.75 percentage points onto it. That is how they calculate the interest rate on your loan. Larger banks use a more complicated formula. However, the margin between what the money cost them, and what they charge you, is the gross profit on the loan. And out of that they must pay all the expenses associated with monitoring and servicing the loan.
No wonder banks are so skittish when lending to a business. 99.5% of the time they have to be right about whether they will be paid back by their customers in order to make their planned return. And part of that is not only whether they will be paid back in full and on time, but what can they do if they aren’t?
Most banks like to see three sources of repayment, and more is always better. The first is repayment from profits generated by the business operations. Second is normally liquidation of collateral. Third is often from calling the personal guaranty of the owner (savings, liquidation of possessions, ability to work at another occupation, etc.). However, sometimes that is from other guarantors such as SBA, related other businesses, etc.
To that end, there are three things you can do to increase your chances of being approved.
Three Tips For Getting a Loan
First, know your numbers! At the end of the day, no matter how great the story you tell about your company, it all comes down to numbers. Your financials should be current to within 60 days of the day you meet with the bank. So if you meet on June 10th having financials for year to date as of 4/1 or 5/1 is expected. That always includes an Income Statement (profit and loss), Balance Sheet, and Accounts Receivable and Payable aging. Then you need the previous 3 years financials or tax returns for the business and your personal returns for 3 years. And you need to be able to explain any unusual items on them. A quick review with the bookkeeper or CPA prior to giving them to the bank is all that is needed. And have a personal financial statement, or personal balance sheet ready and current to the same date as the year to date financials.
Second, explain how you plan to use the money and how it will help your business. The bank wants to know why you want the money and what you plan to do with it. This can sometimes include showing projected income statements to show the positive impact the loan will have on your business.
Third, consolidate your banking. Since banks do not make much on loans, they look to other products for profit. Offering to move your investments, personal accounts, home mortgage, credit cards, etc. to the bank can make you a dramatically more profitable customer. That can result in lower interest rates and the reduction or elimination of some services you may have previously paid for. Recently, I was able to negotiate a $2,500 loan application fee down to $250 by having my client consolidate their banking, and by offering the banks services to my customer’s employees. Down the road, the bank will be very interested in keeping you as a customer, which can sometimes get them to be a bit more liberal on credit or pricing.
Just following these three tips can dramatically increase your chances of obtaining a loan on favorable terms. I should know, since I was the guy who used to make the decision.
Resources:
- Personal Financial Statement: https://1.usa.gov/1nrAjV1
- Net Work Online Worksheet – https://bit.ly/1mvmmEp
Wesley John
Latest posts by Wesley John (see all)
- How do you Reduce Your International Sales Risk to Almost ZERO? - August 11, 2014
- Buying Your Own Office – Should I Purchase Real Estate? - July 14, 2014
- Are Your Assets Working for You? The Return on Assets Ratio - July 6, 2014
