Loan underwriting is the process through which a lender determines whether or not a loan application is creditworthy. This process analyses and assesses the borrower’s ability to repay the loan amount based on a set system which verifies, analyses and summarizes the applicant’s data in an effort to paint a true financial picture of the applicant. This system may differ slightly from lender to lender but the general idea remains unchanged.
Understanding the underwriting process for small business loans is important for every prospective borrower, especially first-timers as it will help you prepare your loan application adequately, which can even improve your chances of securing the loan. So, while borrowing for first-timers might appear to be daunting, knowledge of the underwriting process might just be the first step towards a successful loan application.
Steps to Underwriting Small Business Loans
Income to Repay the Loan
The primary function of underwriting is to determine the borrower’s ability to repay the loan. It is, therefore, very important to assess the business’ ability to repay the loan. Basically, the business should be able to make enough money to repay the loan plus the interest that accompanies it. Underwriters can determine whether your business can make this amount of money by analyzing the business’ financial statements. When it comes to small businesses, the key financial statement is the statement of cash flow which shows your monthly income and expenses. Expect to answer questions and provide information on your current assets and liabilities, net income, revenues and operating expenses. These will help him/her determine whether your business is worth the amount you are asking for. It is, therefore, important to be as open and honest as possible.
Credit
There is no doubt that this is one of the most important factors which underwriters take into consideration when considering your application for a loan. Credit here refers to your credit history. It looks into your loan repayment reputation. Usually, this information is contained in your credit report. The credit report carries detailed information regarding previous loans including how much was borrowed and whether the loans were repaid on time. The Fair Isaac Corporation (FICO) uses this credit report to create a credit score, which gives underwriters a snapshot of the applicant’s creditworthiness even before they take a look at your credit reports. Of course, it goes without saying that a negative credit score reduces your chances of securing the loan.
Capacity
Another factor which lenders take into consideration is the amount of money the borrower has to fund the project he/she wishes to carry out. For example, if you require a small business loan, the underwriter will need to look at the present equity (capital) of your business in order to judge whether or not you will be able to make enough return to repay the loan. Capacity can be in the form of how much money you have put into the company, how much retained earnings you have or in terms of personal assets invested in the business. The underwriter will also compare income against recurring debts and assess your Debt-to-Income (DTI) ratio. Other factors such as job stability and longevity are also taken into consideration.
Collateral
Collateral is a very influential factor when it comes to securing a loan. This is because collateral assures the lender that the loan will be repaid even if the borrower defaults on the loan. The concept of collateral allows the lender to possess the property mortgaged in the event that the borrower defaults on the loan.
Collateral is more of a safety net for the loan as it is only possessed in the event that the borrower defaults on the loan. The value of your collateral is determined by the underwriter. However, collaterals with values that double or triple the amount requested by the applicant increase the chances of securing the loan.
Other Considerations
Other factors which the underwriter may take into consideration may include other sources of income, the ability of the business owner to raise additional capital if required, personal guarantors and/or co-signers. One other very important factor is the honesty of the individual.
Underwriters are first of all human, meaning there is a human aspect to underwriting. In the end, the underwriter has the power to grant you a loan even with a less than average credit standing. Being prepared to offer explanations where necessary and show your strengths might go a long way to strengthen your application.
Take a look at how streamlined, yet detailed, our underwriting can be when we work with you to get funding through us here at FIN$. We’re ready to serve: Underwriting that works for you