Whether you’re a small-business owner, a Fortune 100 executive, or a buyer in search of a new home, it pays to know the ins and outs of borrowing money. Too often, loan-seekers hurt their chances of securing financing by thinking only of their own needs; a better method is analyzing one’s loan application from the perspective of a lender.
When a lender reviews an application or speaks with a potential client, one of the first things they notice is the purpose: that is, what the client intends to do with the loan. The easiest loans to make are those that fund assets with re-sale value: equipment, for instance, or property.
One reason for this is that equipment and property purchases are the ones that will most likely increase a business’s income: if there’s a huge demand for the hot dogs you sell, one can reasonably assume that buying a second hot dog cart will help you sell more hot dogs. Similarly, if your factory tackles crushing demand, building a larger one may well be a wise move.
Another reason is that asset loans are the safest kind to make. If a business fails after its received an equipment loan, it can re-sell the equipment to recoup some of its original value and (hopefully) repay the loan.
Would-be entrepreneurs should look into getting a microloan if they are turned down from the bank. There are microlenders all over the country who are simply waiting to help out these entrepreneurs who are in need of funding.
Lenders know this, so they are more willing to lend for re-sellable assets than for expenses – like rent, payroll, insurance or marketing – that they cannot transform back into cash. It’s this principle that drives down the interest rates on home- and auto-loans (the bank can repo your home or car) and drives up the rates on credit cards (they can’t repo your epic bar crawl or last year’s vacation).
When a lender deems your proposed purpose viable, she must gauge whether the loan is a responsible one to make: that is, whether her bank will get its money back. Various lenders have unique, complicated ways of making this decision, but one set of guidelines pervades the industry: the “Five Cs” of lending: character, cash flow, capital, conditions and collateral.
To assess character, a lender will often combine gut feeling with an assessment of your FICO score and bureau reports. Cash flow is your ability to repay: a second source of income and strong evidence of your ability to earn profit help. Conditions refer to the health of your industry or the economy, and collateral is what the bank can repo in the event of default.
The best way to fund your business (or any purchase) is with your own savings. If you decide seeking a loan is the best route for you, though, you can make the process easier on yourself by viewing it from the lender’s perspective.