Deciding to leave a 9-5 job and open a business is a huge decision. In addition to nailing down the niche, the financials need ironed out as well. But one thing a lot of budding entrepreneurs encounter is a lack of funding. Most people look for outside help, like a small business loan.
Read on to learn the necessary steps to qualify for a small business loan.
What Is a Small Business Loan?
A small business loan is a type of loan that’s issued to small business owners. They function similarly to personal loans; a person is given a set amount of money and is expected to pay it back with interest. However, the terms of the loan will differ between businesses.
One of the most commonly asked questions among small business owners is how do SBA loans work? According to Lantern Credit, “an SBA loan is one guaranteed by the Small Business Administration (SBA) and offered by approved lenders such as banks, micro-lending institutions, and private lending companies”. Furthermore, this type of loan can be used to purchase equipment, furniture and inventory.
Have Good Credit
Whether or not someone qualifies for a small business depends on several factors, one of which is their credit score. A person’s credit score not only plays a role in being qualified, it also dictates how much you’re eligible to receive. The lower the score, the less likely someone is to be approved. The higher the credit score, the more likely someone is to be approved and the amount of the loan can increase significantly.
Having good credit shows that a person is trustworthy and financially responsible. However, that doesn’t mean someone with a lower credit score won’t qualify for small business loan.
But for those with lower credit scores, it does make the lender less likely to approve the loan without collateral or a co-signer. While building a positive credit history does take time, all that’s needed is making mortgage, other types of loans and credit card payments on time every month.
Have a Stable Debt-to-Income Ratio
Regardless of business type, every business has a debt-to-income ratio. Basically, this is the income a business makes every month in comparison to their total debt. Most lenders require this information to determine how much someone is able to pay back on the loan after their expenses are paid and still make a profit.
If the debt-to-income is too low, the loan may not be approved. One way to improve a high debt-to-income ratio is by paying off outstanding debt. Also, it’s better to hold off on large purchases as well.
Prepare to Put Up Collateral
Some lenders may ask for additional loan security in the form of collateral. Collateral lending is essentially putting up assets as insurance to secure lending, so if something goes wrong, the lender can seize those assets and recover their money. Common collateral assets include inventory, equipment and even real estate, like the borrower’s home.
Opening a small business takes research and meticulous financial planning. To avoid being turned down, make sure that all the financials are in positive standing and there is ample collateral, if required.