Why was my loan application denied?

Have you ever asked yourself, “Why was my loan application denied?” This is a question many small business borrowers often find themselves asking after a trip to their local bank, leaving with a denied loan request. The real question should be, “What can I do to improve my odds when I talk to a lender?”

While that might appear to be a pretty straightforward question, the answer may be more dependent on where you decide to look, how much you’re asking for, what your credit profile looks like, how long you’ve been in business, and even the type of business you’re in. Every lender, whether it’s a bank, a credit union, or an online lender looks at a range of criteria when measuring your creditworthiness.

For example, a healthy restaurant might get turned down for a loan if the business owner has a personal credit score of 625 and doesn’t have a track record of several years in business. As a general rule, banks prefer to see borrowers with personal credit scores over 680, they like to see a good number of years in business, and generally don’t like to lend to restaurants (they perceive them as higher risk). Nevertheless, there are lenders who would offer a loan to a healthy restaurant like the one described above.

When a lender is evaluating your business’ creditworthiness, they really want to know the answer to three important questions:

1. Can you repay a loan by making every required periodic payment?
2. Will you make those payments?
3. What will you do if something unexpected happens?

Although the first two questions are very similar, they tell different stories and lenders will likely not ask the questions in this way. Your business revenue and cash flow might answer question number one, but your business track record and past history will provide a better answer to question two. With that in mind, here are 10 questions you should ask yourself (because a potential lender likely will) before your business applies for a loan.

The following 10 questions are part of the Fundability Quiz and have been answered by over 3,000 small businesses over the past several months and helped many of them decide where they should look for a loan, what type of loan best meets their needs, and even indicated where they might need to strengthen their application to increase the odds of success down the road.

What Does Your Business Need the Money For?

This question isn’t usually the first question a lender will ask, but it’s the first question you should ask yourself. In fact, the answer to this question will help drive how much your business asks for and where you should look. Ask yourself, “Am I trying to meet a short-term business need? Or is it a long-term need?”

In much the same way most people would never purchase a new car with a 30-year loan, purchasing quick-turnaround inventory, bridging a seasonal cash flow gap, or ramping up to fulfill the needs of a new contract might be better suited for a short-term loan. The total interest paid to fill a short-term need with long-term financing might make the total interest cost prohibitive or not the right fit for the use. Likewise, purchasing commercial real estate or buying heavy equipment that will be depreciated over several years could be a better fit for a longer-term loan.

Although a longer- term loan is suited to meet a variety of needs, you might be interested to learn the majority of business owners who took the Fundability Quiz were trying to meet short-term needs (62 percent) while 21 percent sought longer-term financing.

What’s more, some lenders are better able to meet one type of financing need better than others. For example, with the exception of a line of credit, many traditional lenders, like banks and credit unions, prefer to make longer-term loans of four, five, or 10 years. On the other hand, many online lenders specialize in shorter terms of six months, 12 months, or 24 months—in addition to offering longer-term loans or lines of credit.

Identifying your loan purpose will help you look in the places where you’re more likely to find the loan term that best meets your business’s need.

How Much Are You Seeking to Borrow?

Loan amount can be another indicator of where to look. Many traditional lending sources would rather lend $500,000 than $50,000. If the costs associated with underwriting a $50,000 loan are similar to those of a $500,000 loan, it’s hard to blame the banker for preferring the larger loan amounts. Nevertheless, many small businesses are looking for loan amounts much closer to the $50,000 loan. It could be said the problem isn’t that the average small business is looking for too much, but rather, not enough to enter the space banks prefer to lend.

The SBA recognized this a couple of years ago and removed the fees associated with the 7(a) loan program on loans under $150,000. As a result, SBA loans in that category have gone up.

Of those who took the Fundability Quiz, over one third were looking for loans from $10,000 to $50,000—likely a poor fit for many banks, but potentially a good fit for many online or alternative lenders.

What Is Your Personal Credit Score?

Although personal credit score might not be the best way to evaluate business creditworthiness, it will likely be part of the equation for most small business applications. Many lenders use it because they’re trying to predict what your business will do in the future based upon what you’ve done in the past. And while many lenders look beyond a borrower’s personal credit score and consider other metrics that demonstrate a healthy business, a low personal score can be a go-no-go metric for many banks, credit unions, and other lenders.

If you know what your personal score is, it can help you save time by avoiding places where you’ll likely be turned away. For example, many banks prefer to work with borrowers with a score of 700 or higher, but their minimum threshold is around 680. The SBA will go a little lower. They’ll work with a borrower who has a score of 650—provided other business metrics are in order. Some online lenders will work with a borrower with a score of around 625 as a minimum cutoff, provided they have a healthy business. And there are some who will go even lower.

Of those who’ve taken the quiz, the majority estimated their personal credit score to be between 500 and 650. By visiting the three major credit bureaus (or one of many free sites available online), you can gain visibility into your personal score and won’t need to guess. In fact, in the United States, federal law requires that at least once every year you can have access to your personal score for free. In Canada, as long as you’re willing to receive a hard copy in the mail, you can see your score as often as you’d like.

How Long Has Your Business Been In Business?

Most lenders like to see a track record of good credit behavior. This is why they want to know how long the business has been running. This is why it’s particularly difficult for a very early stage start-up to find success when seeking a small business loan. Lenders are trying to determine what the business will do in the future by looking at its track record. Without a track record, it’s difficult to make assumptions about what the business may do down the road.

The SBA does offer loans to startups provided the owner has a strong personal credit score and collateral. Most banks however, like to see several years in business (two to five years depending on the bank). Most online lenders require at least a year in business, so they might not be a good place to look for startup capital.

A little over a third of those who took the quiz had been in business less than six months. Roughly a third of respondents had been in business for five years or longer.

While a small business loan might be a challenge for the earliest stage businesses, focusing on building a strong business credit profile in the first year or two of business is a good long-term strategy. Trade credit, or payment terms, with your vendors and suppliers can be a good approach to build a strong business credit profile—provided they report your good credit behavior to the appropriate credit bureaus.

Do You Know How Your Business Credit is Rated?

The lion’s share of those who took the quiz (77 percent) didn’t really know how their business credit profile is created. The three major business credit bureaus, Dun & Bradstreet, Experian, and Equifax, all consider things like how timely your business pays your suppliers, your business’s history with any business credit cards, and how your business pays any other small business loans it may have had in the past. They also look at how your business make its lease payments and whether or not it pays its utility bills on time.

In addition to your business credit history, they also evaluate your business based upon the industry it’s in, the region where it does business, and how similar businesses to yours typically perform. Although some business owners might be familiar with Dun & Bradstreet’s Paydex^® score, unlike your personal credit score, your business credit profile is not expressed in a score, but rather consists of a number of various reports that reflect what your business history has been and what the bureaus predict your business credit behavior might be in the future.

What is Your Industry?

Some lenders prefer to work within certain industries and some automatically disqualify others. There are specific industries, which are considered higher risk than others—another reason you should become well acquainted with your business credit profile. A seemingly insignificant misclassification of your industry could put you in a higher risk category and make it more difficult for your business to qualify for a loan.

Industries considered higher-risk by traditional lenders may include restaurants, auto, recreational vehicle, or boat sales, dry cleaners, and general contractors to name just a few. This list will vary depending upon individual lenders, but it’s fairly representative of businesses that may have a difficult time qualifying for a traditional small business loan. Online lenders typically shy away from industries like real estate brokers, automobile dealerships, and non-profits, to identify a few.

Many of the businesses that took the quiz are those most of us would identify with along Main Street and include service businesses, retail businesses, professional services, and manufacturing.

What is Your Business’ Approximate Annual Revenue?

Many lenders use a business’ annual revenue as one of the metrics they consider when evaluating a business. This is one of the ways they try to answer the question of whether or not your business has the resources to make regular and timely periodic payments. Those business owners who’ve taken the Fundability Quiz range from startups with no revenue yet to businesses with over $5 million in annual revenue.

While different lenders have different thresholds (many online lenders, for example, have a minimum revenue threshold of $100,000), the higher your annual revenue the more likely you’ll find success. In addition to revenue, many lenders will want to validate your business has the cash flow to make the periodic payments; and many traditional lenders usually require two years of profitability in addition to revenues closer to $1 million dollars.

Have You Filed for Personal Bankruptcy?

As you might expect, a bankruptcy can make qualifying for a small business loan problematic. Some lenders will automatically disqualify an application when the business owner has filed for bankruptcy less than five years ago—while others set the date at two years. While some of those that took the Quiz had filed for a bankruptcy in the past, the vast majority had never filed for a bankruptcy.

Depending upon how long ago a business owner may have filed and what their credit behavior has been since the bankruptcy, the business will likely pay a premium for any financing it is able to secure. Before you spend time going through a loan application, it will make the process easier to ask up front if the lender you’re approaching is willing to work with a business when the owner has had a bankruptcy within the last seven to 10 years.

Are There Any Liens on Your Business Resulting From Legal Judgments?

Only three percent of those who completed the Quiz had a lien on any of their business assets from a legal judgment. To one degree or another, most lenders will look negatively at any lien resulting from a legal judgment.

Any open liens may negatively effect your loan application with many lenders; although there are instances and lenders who look more seriously at liens over $10,000.

Does Your Business Own Any Assets That Could Be Used As Collateral?

Collateralizing your business loans with assets (such as real estate, equipment, or other valuable asset), that can be sold by your lender should your small business default on a loan, is frequently required by traditional lenders like the bank. And, although the SBA, in some instances, doesn’t require a borrower to fully collateralize an SBA loan, they will typically require the borrower to provide as much collateral as they have available.

The collateral requirement can make it difficult for even a healthy business that doesn’t have adequate collateral to apply for a traditional small business loan. 60 percent of those who completed the Fundability Quiz answered they didn’t have available assets suitable for collateral.

Other lenders, including most online lenders, don’t require specific collateral to secure a small business loan. They will likely require a general lien on business assets and a personal guarantee to secure the loan during the loan term.

How Can I Improve the Odds of Success When Applying for a Business Loan?

Answering the above 10 questions will help you look at your business loan application the same way a lender might. You’ll be able to determine where you might find success with your business loan application today, and will likely identify areas where your business can improve to increase its options in the future. Although most business owners don’t make the entrepreneurial leap because they are financing experts, it’s important to understand what’s required so you can find the best loan for your business’ situation.

There are more options available than ever before for businesses looking for borrowed capital—but there is no one-size-fits-all loan for every business. There was a time when all your business needed was a healthy record and a good relationship with the bank around the corner. Unfortunately, that isn’t the case today. Financing a small business will likely require a savvier and more strategic approach to finding the capital your business needs to fuel growth and fund other initiatives.