Big Changes in the Business Loan Approval Process

In the not so distant past, when money was cheap and time was tight, a FICO score of 700 and a one-page application was enough to land a $150,000 business loan.In the time it takes to get a drive-thru cheeseburger, some of the biggest small business lenders in America were handing out lines of credit by relying heavily on personal credit scores to rubber-stamp applications. Given that most business loans are unsecured, a lender has little recourse, when a loan goes sour, beyond the personal guarantee of principals. And if the principals backing a loan are broke, a personal guarantee is virtually useless. In a conference call with analysts back in October 2008, former Bank of America (BAC) Chairman and Chief Executive Kenneth Lewis memorably called the deteriorating credit quality of the bank's small business portfolio "a damn disaster."

Today, banks are still reeling from these loans. With purse strings still tight, getting into your lender's head and preparing in advance can mean the difference between denial and approval.

The first step is to understand how the underwriting process works these days: It begins with a review of your personal credit report to assess your character and basic default risk, with much more attention paid to the qualitative sections, including your payment history and public records data. It is this information, not simply the credit score, that can disqualify your application altogether. Banks are looking for obvious red flags, such as previous bankruptcy filings, liens, or judgments. Skipped or missed student loan or child support payments may bring your basic character into question. Lenders are also focusing on late payments of staple expenses, such as mortgage, car, and credit-card payments. Even one late payment will be viewed as an indication you are starting to slip.

The Role of Credit Scores

Next, a lender will focus on your personal credit score to determine if you fit the general risk profile of the bank. Lenders have discovered a strong correlation between the personal credit of an owner and a business's ability to pay back a loan. While business credit reports also include scores, they are used far less frequently by banks. These reports often exclude critical information on a business owner's previous payment history, prior bankruptcies, and outstanding liens, making them less comprehensive. Much of the data reported are voluntary, relying on the cooperation of a business's credit partners, making them a less reliable resource.

While a personal credit score will not make or break your application, it will have significant impact on your borrowing costs. Each personal credit agency has a slightly different take on calculating credit scores (sometimes called FICO, FICO II, or Beacon); depending on the source, your score can vary up to 50 points. While it is hard to generalize a good or bad score, your cost of capital may increase if your score is below 700.

You're not done yet. Get ready to provide proof of income. Even with a blemish-free credit report and high FICO score, borrowers seeking $50,000 or more may be asked to supply up to three years of personal and business tax returns for income verification. This is in addition to financial pro formas and personal guarantees that lenders will otherwise require. Banks want to know that you have the personal resources to backstop unsecured loans. The amount of scrutiny a lender will conduct may depend on its size. A regional bank may have a smaller buffer to withstand loss than a national bank. As a result of their risk aversion, they may seek more protections, including mandatory certificates of deposit.

Follow Up on Credit Reports

With a little planning, it is possible to improve your chances of getting a loan and reduce your borrowing costs.

Start by pulling your personal and business credit report with the major agencies three to six months before you anticipate applying for a loan. Consumer credit reports are available through Experian (EXPGF), Equifax (EFX), and TransUnion. Experian and Dun & Bradstreet (DNB) publish business reports. Review these reports for errors; if you find mistakes, follow up directly with the reporting agency.

Then encourage trade partners—from credit-card companies to suppliers—to report positive payment activity. Much of the coverage provided by the major business credit reporting agencies relies on voluntary feedback from creditors.

John Ulzheimer, president of consumer education at, also suggests paying close attention to three avoidable credit missteps that can sabotage your loan application:

1. Missed payments. Even one late or missed payment can affect your score and your borrowing cost. Be especially prompt with the payment of core bills, including mortgage, car payments, student loans, and child support payments.

2. High credit utilization. Ideally, banks want you to be drawing only a small portion of the credit available to you. If you are regularly drawing 50 percent or more of available credit, apply for new cards. Bear in mind that a bank may start to penalize you if you have dozens of cards with high limits that you never use, especially if these cards once utilized could overload you with an unmanageable level of debt.

3. High debt to income. Lenders will want to see this ratio well below 50 percent when factoring in housing expense.

Finally, be realistic about the amount of credit you seek. Your financial projections should include debt service payments, and your personal tax returns should validate that you have the resources to guarantee payments personally if things go awry.

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