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Finding out that your business loan has been declined can be frustrating and scary, especially if you need the funds to start your business or keep it running. Fortunately, there are a few common reasons business loans get turned down, which can make it easier to bolster future applications and get the funds you need.
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1. Damaged credit score
Credit scores demonstrate to lenders an applicant’s creditworthiness and indicate the level of risk posed by a borrower. Commercial lenders look at both personal and business credit scores when evaluating applications, but new businesses may have to rely solely on the applicant’s personal score. In general, potential borrowers must have a FICO score of at least 680 to qualify.
One of the most common problems with getting a small business loan is damaged credit. If your business or personal score has been damaged by default, bankruptcy, or even just late payments, your business loan application may be denied. Some lenders have lower score requirements, but these options usually come with much higher interest rates.
For this reason, it may be best to choose another form of funding, such as a business credit card or merchant cash advance, or wait to reapply until you improve your score. Follow these tips if your loan application was denied due to bad credit:
- Review your business and personal credit reports to identify areas for improvement
- Update your accounts by catching up on late payments
- Make payments on time to establish a strong credit history
- Take advantage of prequalification tools to see if you’re likely to qualify for a loan based on your personal score
- Limit the number of new inquiries about your report by reducing the frequency of inquiries
2. Insufficient time in business
Commercial lenders typically have minimum business time requirements ranging from six months to over a year. If you’re trying to get start-up money or building a business from scratch, you probably won’t meet these minimum qualifications. Likewise, if you meet the minimum business time requirements but do not have adequate financial records, your loan application may still be denied due to insufficient business time.
Keep in mind that minimum business time requirements vary by lender and type of financing, so research the options before applying. If you’ve ever been denied a loan due to a lack of business time, look for alternative loans with less stringent requirements. You can also consider waiting to reapply and start your business for as long as possible.
3. Cash Flow Limits
In addition to requiring a minimum amount of time in business, many lenders require applicants to demonstrate a minimum amount of monthly or annual income. This number depends on the lender, as well as the amount of the loan and the type of financing, but it generally ranges between $100,000 and $250,000.
Even lenders that do not impose a minimum annual income require financial documents that demonstrate sufficient cash flow to cover operating expenses as well as current and future loan repayments.
If your loan application was declined due to insufficient cash flow, take steps to better understand your business income and expenses. This may include using accounting software to monitor weekly cash flow and generate cash flow reports and projections. Not only can this strategy help you qualify for future loans, but it can also give your business a greater likelihood of long-term success.
4. Not enough collateral
Many lenders also hedge their risk by requiring borrowers to back loans with valuable business assets. In the event of default by the borrower, the lender may seize the asset with the aim of recovering the outstanding balance of the loan. For this reason, the loan collateral must be of sufficient value to cover the outstanding loan amount. If your business is new and lacks collateral, or your assets are already pledged, this may result in a loan application being declined.
Choosing a lender who offers unsecured business loans can help you overcome this obstacle. Many alternative lenders also provide access to funds without providing traditional collateral. However, unsecured loans pose a higher risk to lenders and often come with higher interest rates and fees to compensate for this risk.
5. Missing documents or information
The best small business loans involve a streamlined and easy-to-navigate application process. However, many lenders have complex application forms and often require detailed documentation. Not only can failure to provide all requested documents delay the review of a business loan application, but missing documents or other information can also result in a loan being denied altogether.
Fortunately, it can be easy to correct an application that is missing documents or information. Most lenders contact applicants regarding outstanding requirements as part of the application review process. For this reason, it is important to monitor your phone and email for communications from the lender. If, however, your application was declined due to missing information, compile the most common application documents before reapplying.
Here are some of the most common documents requested during the business loan application process:
- Personal and business bank statements
- Personal and business tax returns
- Financial statements, including profit and loss accounts
- Relevant legal documents, including business licenses and articles of incorporation
- Business plan showing how the business makes money, including projections
6. Too much existing debt
A company’s debt utilization rate, or credit utilization rate, is the portion of a company’s credit limits that it is currently using. Generally, lenders prefer an applicant’s debt utilization rate to be below 30%. If your business has a higher credit utilization rate, it may be considered maxed out and too risky to qualify for a loan.
Conversely, some lenders refrain from lending to companies that cannot demonstrate sufficient use of credit. Although it may be counter-intuitive, it’s worth remembering that consistent and responsible use of credit tells lenders that your business can manage debt responsibly and therefore has less risk of non-payment.
If you’re trying to get a business loan but your business is turned down due to high debt utilization, take the time to pay off outstanding balances before reapplying for a loan. Businesses with close to zero utilization should begin accessing their current lines of credit and establishing a solid repayment history before reapplying for a loan.
7. Risky Industry
Regardless of your qualifications, getting a business loan can be difficult if you work in a risky industry. For example, lenders generally consider restaurants to be riskier than other types of businesses because incomes can be unstable and failure rates are high. Likewise, many lenders will not provide funds to businesses in agriculture, construction, or so-called vice industries like gambling.
Although you cannot change industries to meet lender requirements, you can change lenders. There are a number of alternative lenders that cater to riskier industries and offer types of financing better suited to those industries. That said, these lenders may require collateral or charge higher rates and fees to compensate for the added risk.
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