The three main criteria lenders look for in a business loan

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When I work with loan applicants, there's three main criteria that I share with them that are really going to impact their chances of getting approved for a business loan. The first one, and really the main one is called debt service in your personal life or with personal loans, it's often referred to as debt to income. In the business loan world, it's called debt service or debt service coverage ratio DSC R. And the way this is calculated is taking all your income versus all your expenses plus any sort of new loan payment you would have and then coming up with the ratio and debt service is almost always the primary source of repayment for a business loan. Again, lenders like to get repaid and the way that they get repaid from a loan is by the cash flow that the business and or the people signing guarantees have available to make payments on that loan.

So debt service is almost always the primary source of repayment Frankly, in a lot of instances, debt service is about 80% of your approval, meaning if you can show you have the appropriate level of debt service, most likely, you're going to get approved for the loan. Essentially debt service is money in versus money out. And the way this ratio works is lenders like to see a 1.25 debt service coverage ratio. And what that means is here on the third bullet is that you can show you have $1 and 25 cents coming in for every $1 going out, and that includes the new loan payment. Now one of the things to keep in mind with debt service. When I talk about money coming in versus money going out, this is not just in your business.

Yes, they will calculate the debt service coverage ratio of the business by itself, but they will also take a look at all of the owners of the business and think about the income base. Have coming in, versus the debt or the expenses they have going out. So for example, if they're calculating your debt service coverage ratio, and you have a car payment that is not in the business's name, that is still going to be counted toward money going out. Therefore, they're going to want to see some income coming in. On the personal side. This is also true across multiple businesses.

So if you are a business owner, and the lender is calculating your debt service coverage ratio, they're likely going to ask you for tax returns on every single business that you own, because each of those is going to contribute either toward your income or and or have expenses that it will contribute. So just keep in mind that debt service coverage ratio is the key criteria that will be looked at by most lenders. Again, just like other criteria by itself, it will not get your loan approved, but this one is highly, highly important. Now, the second key crisis material that I tell borrowers to focus on is if they have any sort of collateral that they can offer to the lender. In many instances, you'll want to apply for what's called an unsecured loan, meaning you're not giving or assigning collateral to the lender. But having collateral available to assign to the lender improves your chances of getting approved.

And collateral is often considered the secondary source of repayment after debt service. So if you accomplish and you can check off debt service, and you can check off collateral or available collateral as a secondary source of repayment, you're in really good shape. Now, this means that you have secured loans when you give a lender collateral versus an unsecured loan is when you're giving them no collateral other than your signature whatsoever. Now, collateral is generally fixed assets that the lender can take away from you and sell to recoup their money if you do not make your payments on time or you default on the loan. When we talk about fixed assets, what we're really talking about is tangible things, such as real estate, which is really a preferred piece of collateral for just about every lender, or equipment, or furniture, fixtures, these type things, they're actual tangible things that the lender can take and sell in order to recoup their funds.

And what the lender will do is they will likely lend only a certain percentage of your collateral value. So for example, if you are giving them real estate as collateral, and you want $80,000, they will generally give you a percentage of the value of that collateral toward your loan. And we'll talk more about loan to values here in a future lesson. So debt service is your primary criteria followed by collateral and then your third criteria is what we would call liquidity, or the easy way to remember this is how much cash you Have liquidity does include cash and what is called marketable securities, which are investments that can be sold in the market to recoup the cash that was put into them. liquidity demonstrates that you have savings or money or an emergency fund to fall back on in case the business isn't kicking off enough cash to make that debt service or to pay the loan.

And so having some cash on hand is very important. It also shows your liquidity your cash on hand shows that you have the ability to make your equity injection, which is really just a fancy way of saying that you are going to put some skin in the game. Again, when we get to loan to values. In a later lesson. We'll talk about this but your equity injection comes out of your cash that you have available. If you have $20,000 in cash, and the lender is going to give you $80,000 of the hundred thousand that you needed.

Then you have to take that entire $20,000 in cash to put toward the purchase of whatever You are buying maybe a piece of real estate. So in that instance, what's going to happen is the lender will recognize that you're going to use every bit of liquidity that you have available to you. And that could cause some concern for them, because then you will no longer have a rainy day fund or any emergency funds. Again, we'll talk about loan to value in a future lesson. But just to reiterate, remember that you have three main criteria that I really want you to focus on. The biggest one is your debt service, your ability to pay back the loan, and the calculation that they do.

They're looking for a 1.25 $1 and a quarter for every dollar going out, including this new loan payment. Next, they'll look for available collateral that you can assign to them. Now remember, they're not going to take your collateral away from you immediately. You'll still retain ownership of that. It's just that the lender can come take it if you stop making your payments. And then finally, they want that liquidity they want your cash for two purposes a to show this You've got some money to fall back on if things get tight.

And then secondly to make your equity injection toward whatever the purchases that you're making

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