Get it right: Knowing what financiers look out for in loan applications and taking steps to improve in these areas may make you more eligible for a loan. Photo credit: Unsplash
What is the first thing SME owners like yourself would think when deciding if they should apply for a business loan? The answer is pretty straightforward: Whether they would be eligible for one.
Another reason to apply again is because business conditions may have changed since your last application. Maybe your business is doing better now or your credit rating has improved.
Bear in mind too that throughout the year, there are peak periods for loan applications – typically in the early to middle part of the year. Closer to the end of the year, the volume of applications may drop as people start clearing their leave or drawing up holiday plans.
Let’s take a look at five factors that affect your loan eligibility.
The type of loan you choose has a direct bearing on the loan quantum and tenor. This is why you need to make sure you choose the right type of loan for your business needs.
Before you make a formal loan application, think about what you need the loan for. Do you need it to increase your working capital, buy equipment or materials, or solve short-term needs such as payroll?
It may be difficult to get a secured business term loan from a bank if your business is fairly new (less than two years old) and not profitable yet. If you do not have assets such as property or a car, you are not likely to get a secured loan. You could opt for a short-term unsecured loan, but you will need a guarantor.
But all is not lost. You can opt for other types of loan solutions such as invoice financing or invoice factoring, which rely on the eventual payment from your buyer, hence reducing the burden on your new startup or stressed financials.
Both can help you to shorten the seemingly interminable 60-day payment cycle – which will allow you to accept more orders without being hampered by when your buyer makes payment.
Once you have figured out what type of loan works best for you, the loan quantum and loan tenor will follow.
These are fixed assets that the bank or financier requires as a form of security for secured loans. You need to be the owner of such collaterals.
In the event that you default on the loan and are unable to make repayments, the financier will recover its losses from the asset that you pledged.
Some examples of assets would be invoices, equipment, a vehicle, or a residential (non-HDB), commercial or industrial property.
Some types of collaterals may appeal more to certain lenders, while some may not. It all depends on the purpose of the loan, the loan quantum and tenor.
The lender will determine the value of the asset and decide whether or not to grant you the loan after taking other factors into consideration.
For instance, if your asset is depreciating in value, the lender will appraise it based on its estimated value at the end of the loan tenor, instead of its initial market price.
Sometimes, the lender may request that you pledge more assets if the collateral you are pledging looks set to depreciate further.
At any rate, property remains a popular choice for collaterals and it is not hard to see why in such an uncertain business climate. It is important to also understand that your loan-to-value (LTV) plays a huge role in the final loan determination. Banks typically work at around 70-80% on the property valuation, while private lenders can go up to 90% at a higher interest rate.
To get an estimate of how much your property is worth, use this free property valuation tool, which will give you an estimate of your property’s value, as well as that of other buildings in the vicinity.
To financiers, loans are liabilities. So the more existing loans you have on hand, the less likely you are to get a loan as your risk of defaulting is high.
Banks use the term “overgeared” to refer to businesses that have more loan commitments than they would prefer.
Although some financiers have a higher risk appetite compared to banks, most of them are generally wary of businesses with such liabilities and will exercise great prudence when it comes to granting loans to them.
This is to minimize their risks in case of a default.
Sometimes known as DRR (Debt Repayment Ratio) or DSCR (Debt Servicing Current Ratio), the DSR is calculated in various ways by different financiers.
But its basic definition remains the same: It refers to your business’s cash inflow against its regular debt outflow. It can be calculated monthly by using bank statements that detail the monthly credits at the end of the month; or yearly, by using financials that are categorized under the cash assets and financing segments.
If your DSR is higher than 1.0, it denotes that your company is able to retain more cash than it is spending on repaying loans. Most banks prefer a higher ratio of 1.20-1.25.
If your DSR is lower than 1.0, it is likely to affect your chances of securing a loan. This is when you should consider refinancing some of your liabilities to stretch out repayments and reduce your monthly instalments. This will not only reduce your cashflow burden, but also increase your chances of getting additional financing for working capital needs.
The BTI ratio is calculated by adding the total unsecured interest-bearing balances across all financiers divided by your monthly salary.
It is used as a gauge to prevent individuals who already have taken on a considerable amount of debt from accumulating even more debt that they won’t be able to pay off.
Since 1st June 2019, a financier is not allowed to grant additional unsecured credit to an individual whose BTI ratio has been exceeded 12 times for three consecutive months.
This means the financier cannot disburse more than the existing limit, increase credit limits, or grant new credit facilities to such borrowers.
Hence, if your BTI ratio has been exceeded for the past few months, your chances of getting a loan are very low – unless the lender has a high risk appetite.
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Belinda loves thinking about random stuff, and collecting useless bits of facts and trivia. She often roots for the underdog, and believes the world needs more happy endings.