In today’s financial climate, it’s pretty tough for small businesses to begin, grow, or to stay afloat. And, the only choice for small ventures is to go about getting a loan.
The appropriate use of bank financing can mean consolidation of debts, provision of capital, and access to expansion. But, banks offer loans to small businesses based upon the five big ‘C’s.
The five big ‘C’s of credit are capacity, collateral, capital, character, and conditions. So, if you happen to be a small enterprise, then you need to spiff up these areas before you apply for a loan, especially if you are actively seeking to get one.
So, discuss your options with various lenders if you need money to start the business. Do all the necessary research, both online and the relevant market, to fine-tune all your ideas. And, if you don’t know where to start, then try Nav Business Loans, as they have plenty of professionals to help out upcoming entrepreneurs in the right direction.
Now, let’s discuss the individual aspects to understand the importance of the five ‘C’s.
Banks tend to look at your reputation or ‘character’ before extending a loan. The character of the company entails credit history. The credit history of any company involves the number of various debts a company has, the frequency with which a company takes up loans, and the speed with which the company pays back loans.
So, it’s all about how well you manage a loan and also how well you’ve managed to utilize it. If you happen to be a company that’s taken up a loan and expanded your business, proffer a profit, and paid back all your debt installments on time, you’ll likely get the next loan with ease.
Character is perhaps the most essential of the five ‘C’s, and it is what determines your FICO score. The higher the score, the more likely you’ll qualify for the loan. The better the credit score, the lesser the interest rate, as well as, the more time you can get to pay back your debt.
The surest way to improve your FICO scoring is to pay all your bills on time, every time. Setting up an online system to pay bills helps to get the job done with minimal effort. If you get a co-signer with an excellent FICO score for the loan you want, you are probably going to have to pay back at lower interest rates too.
Another vital element that is considered by financing companies before extending a loan is capacity. Any lender is going to look at your cash flow, the number of variable assets, employment history, and outstanding debts. These elements are taken into account to determine the ease with which the small enterprise can pay back the loan.
Thus, lenders use the DTI, also known as the debt to income ratio, to estimate your capacity. The DTI is a ratio between your gross monthly income (before tax) and the current debts you have. The lower the debt to income ratio, the more capable you are to take up more debt.
The best way to have a decent DTI ratio is to reduce the number of debts you have. Besides, taking up more loans does more harm than good for a small enterprise in the long run.
There are two types of loans that you can get, secured loan and unsecured loan. If you have a good FICO rating, you can get an unsecured debt. But, if your credit history doesn’t look too good, then you will have to put up collateral against the debt.
The fundamental difference between a secure debt and unsecured debt is collateral. Collateral is the asset you agree to give to the bank in case you default on the debt.
The lender will assess the value of the collateral, plus any debt that has already been taken up against it. And, if the leftover equity is enough to cover the loan you are getting, then you qualify. If not, then the bank may ask you to make a deposit to cover the gap between the two amounts.
Lenders use LTV or the loan to value ratio to determine whether or not to extend a loan. The lower the LTV, the safer the bank’s investment. And, if you then default on your loan, the bank will be able to recover its losses with relative ease.
The money you put towards the loan is the capital. Its also known as the down payment. A down payment can be cash or can include other types of personal assets or investments.
If you put up some of your own money towards a loan, then you can expect more favorable loan conditions. On the other hand, many small businesses cannot extend capital. This doesn’t necessarily result in a refusal for a loan extension. Lenders do tend to evaluate the potential business growth capacity too.
As mentioned above, for small ventures, banks tend to look at other conditions that may apply. For example, a new small business with growth potential yet no capital may receive a loan with favorable loan conditions too.
Also, lenders tend to evaluate the current economic conditions and the industry that you work in before extending loans. For example, many restaurants seeking to stay afloat amid the coronavirus got loans at high-interest rates. But, small food catering businesses and small face mask manufacturers got loans at reduced interest rates as the demand for face masks was huge. And, people were welcome to the idea of ordering food but against the concept of going out to eat during a pandemic.
Starting up a business venture, be it small, medium-sized or a huge business, keep in mind that it always has multiple risks. A thorough evaluation of every aspect is a must. And, for small businesses, it’s best to take baby steps rather than to put all your eggs in one basket and suffer an epic loss.