The age-old question among small business owners: Why is it so hard to take out a business loan? The truth is, qualifying for a business loan doesn’t have to be complicated – you just need to know where to look for one! (And no, banks aren’t always the answer.)
In this article, we’ll discuss the challenges self-employed professionals and small business owners face when securing a small business loan, including tips on how to qualify and where to get a loan.
The Challenges Self-Employed Professionals and Small Business Owners Face
Here are some of the most common challenges small business owners face:
1. No or Insufficient Personal Stake in the Business
Lenders often approve loan applications if the business owner has a reasonable amount of capital invested in the business. They aren’t too keen on approving applications from small businesses that rely too much on outside funding.
2. Low Income and Large Debt
Income is another major determining factor when it comes to evaluating small business loan applications. Companies that are bombarded with expenses and haven’t secured a steady income stream may have a hard time qualifying for a loan. Without sufficient income, it’s harder for you to prove that you have the financial capacity to repay the loan.
3. No Collateral
Lenders often ask for collateral to secure a loan, but many self-employed professionals and small business owners don’t have high-value assets. If you don’t have business assets, you may need to use your home as collateral, which can be risky.
4. Poor Credit Rating
Your credit rating is a major determining factor for lenders when it comes to loan approvals. They use it to gauge your creditworthiness and your likelihood of repaying the loan on time. If you have an insufficient business credit history, lenders will ask for your personal credit reports. Keep in mind that the higher your score, the higher your chances of approval.
For business owners with low credit scores, there are ways to increase your score before applying:
- Pay your bills on time.
- Review your credit reports and correct any errors.
- Limit your requests for “hard” credit inquiries.
- Keep old accounts open and manage your delinquencies.
- Try consolidating your debts.
5. High Failure Rate for Small Business Loans
According to a survey conducted by Biz2Credit, big banks only approved 13.6% of small business loan applications in August 2020. This high failure rate is one reason why small businesses find it hard to qualify for a loan.
Big banks are often wary of startups and small businesses because of the lack of business history, low credit scores, and poor cash flow. If you’ve been denied a bank loan, you can try applying for a loan from alternative online lenders. These lenders have a high approval rate for startup companies and small businesses.
5 Ways to Increase Your Chances of Qualifying for a Loan
When it comes to getting a loan, most people don’t know what to do. Some don’t even know how to get one. But loans can be advantageous and very handy in times of desperate or immediate financial needs. So understanding how to get them can certainly be worth the effort.
Like with most things in life, though, there are requirements or conditions that need to be met for you to qualify for a loan. So if you want to increase your chances of being accepted a loan, you should do and prepare certain things beforehand.
1. Improve Your Credit Score
One of the first things that lenders like to look into is your credit. They highly value candidates who have a good credit score. So before you talk with a lender, consider improving your credit by clearing up any negative balance, making payments on time, and keeping your credit balance low. All of these signs will let the lender know that you are dependable.
2. Create a Business Plan
If you plan to get a loan to start a business, you need to make sure that you have a business plan. A business plan outlines all there is to know about your business, such as what it is, what it offers, and even its expected profit. A business plan is important to lenders so that they can see if your business will succeed enough to pay off your loan. So the more detailed your business plan is, the better your chances are for the lender to accept your application.
3. Prepare Collateral
If you want a loan but do not set up a business or don’t have the logistics to create a business plan, you can offer collateral instead. Homes or other properties are typically used for collateral since these have great value. Even though there is a risk of losing whatever you offered as collateral if you don’t pay off your debt, this method can definitely help you become a candidate for a loan.
4. Have a Higher Income than Debt
For obvious reasons, lenders want to be confident that your business’s income will be higher than your monthly loan debt. If you already have a business and want a loan, then this is a factor that you should take into account.
To prove to the lender that your business’s debt-to-income ratio is reliable, you want this ratio to be no more than 36%. You can achieve this by increasing your monthly income, increasing how much debt you pay each month, or putting off any kind of large purchases like non-essentials. All of these will show that you are trustworthy with money.
5. Invest in Your Business
Another way that you can reach an optimal debt-to-income ratio is by making and showing your investments in your business. This factor also influences your debt-to-equity ratio, which lenders use to compare your loan request and current business investments.
So by directing portions of your income into investing in your business while fully paying off your debts, you will signify to the lender that you can both grow your company and pay off your loan.
Types of Loans Small Business Owners Should Know About
Besides knowing how you can improve your odds of getting a loan approved, you will need to know the different types of loans. That way, you can determine for yourself what would best meet your financial needs.
1. SBA Loans
SBA stands for Small Business Administration. This is a loan where the lender will receive a portion of the debt payment from the government. So regardless of whether the loaner can pay off the debt or not, the lender will still receive their due pay.
But this type of loan is great for business owners since the rates are typically low, and the terms are usually more lenient than other loans. With the SBA loan, you can borrow a maximum of $5 million.
2. Short-Term Loans
Short-term loans are used for quick and not-so-large loan requests. So this can be an ideal method of loan for startups. You can borrow up to $250,000, but these loans are usually paid off within a year. Upon request, however, you can receive the money within two days.
3. Long-Term Loans
As the name suggests, this type of loan is more for already established businesses looking to grow. That is because you can pay off this debt for a more extended period of several years. The monthly rate for a long-term loan is low but has a maximum loan of only $100,000.
4. Unsecured Loans
With unsecured loans, you don’t need collateral to qualify. However, this is a riskier deal for lenders, so the interest rates are usually higher, and borrowers are required to have high credit scores. Alternative online lenders typically offer unsecured loans, and you’ll be able to receive up to $50,000.
5. Secured Loans
On the other hand, you need collateral to qualify for a secured loan. This can be in the form of property, vehicles, inventory, equipment, and other high-value assets. It’s easier for borrowers to qualify for a loan with collateral, and lenders often charge lower interest rates than unsecured loans. However, keep in mind that lenders have the right to repossess your asset in case of a default.
6. Merchant Cash Advance
A merchant cash advance is best for business owners who need fast cash. This financing option is technically not a loan but an advance against your future card transactions. Lenders automatically deduct a predetermined percentage from every sale.
It’s one of the fastest and most convenient ways to get funded because you don’t need collateral, and you can receive the money almost immediately. However, this convenience comes at a price as the interest rates can be really high, so be sure to proceed with caution.
7. Equipment Financing
Equipment financing provides you with the money needed to buy or lease equipment for your business. The equipment you’re going to get acts as collateral for the loan, which means if you fail to repay the lender, your equipment will be repossessed.
8. Invoice Financing
Invoice financing allows you to use pending invoices to secure funding. You can sell these invoices to lending companies in exchange for immediate cash, so you don’t have to wait for 60 to 90 days to get paid. Lenders can give you up to 90% of the total invoice value upfront and give you the remaining percentage (minus a small fee) once your customers pay their dues.
Conclusion
Qualifying for a small business loan isn’t rocket science, but you need to know what your business needs before you apply. Assess your business, do your research, and compare your options to choose the best loan for you.
