4 Steps to Take After Being Denied a Business Loan
Just because your business needs a loan, doesn’t automatically mean you’ll qualify for one. If you go through the taxing process of a loan application and are rejected, don’t get discouraged. Here are four steps you can take to increase your odds for approval the next time you apply:
Step 1. Understand Why You Were Rejected
While you can’t change a lender’s mind once they’ve rejected you, you can ask them for an explanation as to why they did. Here are some of the most common reasons for loan denial:
1. Your business doesn’t have an established credit background. One of the first things that lenders look at when evaluating an applicant is the business’ credit history. Essentially, they want to see a solid track record of debt repayments. If you have little borrowing history (as with start-ups), or a history of missed payments and loan defaults, lenders will see you as a high-risk borrower.
- Your credit history will also reflect your credit score. Credit scores typically range from 300 to 850 and scores above 690 are considered good credit scores.
- One way to improve and establish a good credit background is by taking out a line of credit or applying for a business credit card. These types of loans usually don’t require businesses to have an excellent credit rating to qualify. Plus, you can personally guarantee the credit to improve your chances of approval and get better terms.
2. You don’t have enough cash flow. Along with assessing how responsible you are for repaying loans, lenders would also want to know if you will be able to afford the required payments. They want to see if you’ll have enough money left to pay for the loan on top of your inventory, rent, payroll, and other expenses. If the bank sees that you have more money coming out than going in, it reflects a problem with your cash flow.
- One way of solving cash flow issues is to send invoices on the same day each month. You can use an invoicing tool like Wave to automate your invoices, so you won’t forget to send them to your customers each month.
- Cut costs if you can. Review your business expenses each month and try to see which areas you’re spending a lot of money in. Try to assess if there’s something that your business can do without (i.e., espresso or vending machines). You can also ask your employees to unplug appliances that are not in use or turn off the lights in an empty room to save on utilities.
3. You have no collateral. Collateral is an asset that the borrower pledges as a security for the loan. Lenders usually require business owners to present one, especially if they’re applying for a significant amount. With security, they can acquire the asset the borrowers pledged as payment in case of loan default.
- If you’re pledging collateral, some of the most common assets you can put up include equipment or machinery, real estate, invoices, inventory, or purchase orders.
4. Your business is too young. Lenders may also reject a business loan application if a company is still in its early stages. These types of companies usually have not yet established a track record of healthy revenues so lenders are less likely to see them as suitable candidates for business loans.
- Instead of applying through banks or for comprehensive business loans, businesses can apply for loans via online or alternative lenders. They are usually more lenient than banks and may accept borrowers with a less than ideal credit score and history.
- Start-ups who can’t qualify for a loan through banks or alternative lenders may also benefit from crowdfunding. This is a funding solution where people come together to pool money via the internet to help you raise capital for your small business. In return, your “investors” receive something for their investment, like company stock.
Step 2. Improve Your Business’ Financial Standing
Once it’s clear to you why the financing company rejected your loan, the next thing to do is to work on improving your business’ financial standing. This will help increase your odds of business loan approval in the future.
1. Assess your debt-to-income (DTI) ratio. You can calculate your debt-to-income ratio by simply dividing your debt by your gross income (income before taxes). The resulting number will help lenders measure your ability to meet the required payments for the money you’re planning to borrow.
- Ideally, businesses looking to apply for a loan should have a DTI of less than 36%.
- One of the factors that can affect your DTI is the amount of credit you currently owe. If you’re seeking to lower your DTI ratio, paying off some of your existing debts would help. This will reduce the amount you owe and increase your gross income since you’ll have lesser debts to pay for.
2. Improve your credit score. If the reason behind the business loan rejection is a low credit score, there are some steps you can take to improve it.
- Pay your bills on time. Even a single missed payment can lead to a 180-point decrease in your credit score.
- Avoid closing old accounts. Even if you’ve paid off the debt from your previous loans, keeping them active can increase your available credit, which can increase your credit score.
3. Fix errors on your credit report. Practice checking your credit report from time to time. Credit bureaus sometimes fail to post payments, when in fact, you were able to make payments for that month. Pinpoint these mistakes immediately and call the credit bureau to fix it. This will ensure that your current report is accurate.
Step 3. Consider Short-term Strategies for Loan Approval
When you’ve decided to reapply for another loan, consider the following to increase your chances of approval.
1. Personally guarantee the loan. If you have an excellent personal credit score, a personal guarantee for the loan could improve your chances of approval. With a good repayment history, lenders are reassured that if the business becomes unable to pay for the business loan, the owners would still pay for the loan themselves. This adds another layer of security on the lender’s part.
2. Get a co-signer on board. A co-signer is a person who, in the instance of loan default, is obligated to pay for the loan in place of the borrower who is unable to do so. They usually have better credentials than the borrower. It’s a viable solution if your personal credit score is low, and your income is not sufficient for approval. Your co-signer could be your spouse, friend, or business partner.
- The cosigner should agree to apply for a loan with you. He or she should be aware of the risks as well as the terms that are underwritten in the agreement. They should understand that if they cannot pay the loan, it would also hurt their credit standing.
3. Present a Collateral. Presenting collateral will increase your chances of getting loan instantly approved. If you’ve collected enough business assets, you can use it as collateral for your business loan application in the future.
- When using collateral, you should offer an asset of equal or greater value for the loan.
- Other times, presenting collateral will lead to better terms and lower interest rates because of the added security.
4. Apply through online lenders. If you need quick access to cash, applying for loans through online lenders are the fastest way to go. You can find a lot of online lending companies that will approve your business application within 24 hours.
- Business plans are among the many documents you have to submit to banks and large financing companies for business loan approval. If your business doesn’t have one, and you need quick cash, going to an online lender could be a viable solution. Online lenders are more interested in your revenue than your entire business structure.
- Online lenders also work well with start-ups. Banks see small, start-up businesses as high risk because of their unestablished credit background and short experience. As long as you can prove a healthy revenue stream with online lenders, you’ll be a perfect candidate for an online business loan.
Step 4. Reapply for the second time
Finally, you’ve fixed your credit scores and improved your financial standing. Now you’re ready to reapply for the second time.
1. Choose the financing company carefully. Business loan applications are a big decision, and you want to be sure that you’re working with the company the gives you the best loan terms.
- Shop around for loans from different financing companies. This will give you a chance to compare terms and pick the one that best suits your company’s repayment capacity at the moment.
- Before committing and signing the contract, be sure to review the underwriting first. This will help you know what fees you have to pay on top of the repayments. Additional charges could include service or processing fees, prepayment penalties, or late payment fees.
2. Prepare the needed documents. Sometimes, some loan application rejections could result from failure to submit the right documents. Be sure to secure the necessary papers so that you can supply it right away when the lenders ask for it.
- Before applying, make sure to have a checklist of the documents that the lenders need for the loan. The most common documents they ask for are:
- Personal and business tax returns
- Bank statements
- Balance sheets
- Cash flow statements
- Government-issued ID’s
- Resumes of managers
- Articles of organization
- Business lease
- Business plan
3. Submit Your Documents and Application Form. Fill out an application form and submit all the documents that the lenders need. Depending on the type of loan you’re applying for, it could take weeks to a few months for the company to approve your application.
- SBA loan approvals usually take longer because of the heavy background check they conduct for each potential borrower. Usually, applicants get approved within 30 to 60 days.
- Some online lenders could approve your loan as fast as 24 hours. All you have to do is fill out their forms on their website and submit cash flow and bank statements online.
One loan rejection isn’t the end of the road for businesses. In case you didn’t know, a lot of business owners have been in the same situation as you. While it can be disappointing, it’s also a great learning moment. With loan rejections, you can think of more strategies to improve your business’ financial standing. By doing this, you can put your company in a better position financially and increase your odds of loan approval in the future.
If you’re ready to correct your mistakes and reapply for a loan, follow the steps above to improve your chances of success.
(This article is authored by SMB Compass, business finance company based out of New York)