In order to be considered for a loan, you’ll need to meet the eligibility requirements. But from there, how do lenders actually decide whether you’re a worthy borrower or not? In short, lenders assess your application through a process called underwriting. An underwriter’s job is to make sure that you aren’t too much of a risk for the lender to take on. They want to be absolutely sure that they can get their money back if all goes wrong and you default.
Here’s what you should know about the underwriting process – and how to tip the scales in your favour.
How does loan underwriting work?
After you’ve submitted your loan application and required documents, you don’t have much else to do but wait. But the lender’s job is just beginning.
First, everything goes to an underwriter. An underwriter determines the risk of offering you a loan and then compares this risk against a lender’s parameters to decide whether it’s acceptable. There was a time when lenders evaluated applications manually, but many lenders today automate the process with underwriting software and proprietary algorithms. Automated underwriting means that lenders can approve your application in a matter of minutes — rather than in weeks or months.
What factors do small business loan underwriters consider?
Underwriters take into account a lot of different criteria, depending on who you’re borrowing from and the type of loan you’re looking for. Factors include:
Your business’s monthly revenue. Lenders don’t want to lend you money if you’re unable to prove that your business brings in enough money to pay it back. Many lenders require businesses to make at least $5,000 a month.
Time in business. Many lenders will want to see that your business has been operating for at least one or two years. This is because startups and business less than a year old have a higher likelihood of folding.
Your personal credit score. To a lender, having good personal credit proves you have experience managing debt. Some online lenders don’t pay as much attention to credit scores as banks will, but solid creditworthiness never hurts.
The value of your collateral. If you’re taking out a secured business loan, lenders want to make sure that your collateral is at least worth the amount you’re asking to borrow (or close to it).
Other sources of repayment. Underwriters will consider other ways you could repay your loans, like personal savings or assistance.
Personal equity. Did you help finance your small business when it was just starting up? Maybe you invested your own personal assets. Lenders like to see that you have something at stake when you’re applying for a loan.
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How do I explain financial gaps to a lender?
Automated and electronic approvals typically require your information to fit in specific fields and boxes, squeezing out the ability to explain financial gaps or clarify information.
If you’re worried about presenting a clear, complete picture of your business revenue, consider going with a lender that uses manual underwriting. Keep in mind that a manual process can require more time than one that’s automated — and that your explanation might still not be enough for approval.
Leverage your loan application with a business plan
Revenue, tax forms and other documentation might not tell your business’s whole story. If that’s the case, a business plan can make all the difference. This document is where you get to make a case for yourself when you’re borrowing from a lender that uses manual underwriting.
Understanding underwriting ratios
Underwriting ratios are frequently the most important criteria lenders use when deciding whether to lend you money. The idea is to tell your lender that you have enough assets to pay back your loan if you default.
Four financial ratios to know:
Debt service coverage ratio. This ratio compares your businesses income and assets with the total amount of funding it has already borrowed. You might have trouble with approval if your debt service coverage ratio is below 1.25.
Debt-to-asset ratio. Underwriters often consider this if you’re applying for a loan without collateral. They want to make sure you have enough in assets — usually equipment or property — to cover the cost of the loan in the event that you default. Lenders typically look for a ratio of more than 1.0.
Loan-to-value ratio. In this case, value refers to your collateral. Make sure that it’s worth at least the amount you’re taking out. It should be at 0.8 or lower — meaning that your collateral is worth at least 20% more than the amount you want to borrow.
Ratio of net worth to loan size. Comparing your bussiness or personal net worth — meaning financial assets and debt — to the loan amount is another way that underwriters make sure you can afford the loan. Something close to 1.0 is ideal, but some lenders might be more forgiving.
Bottom line
It’s important to consider your lender’s underwriting process when looking for a business loan. Loan underwriting differs by lender, but you’ll more often end up with a lender that uses automated underwriting software — especially if they promise a quick response.
If your application needs some additional explaining, you might want to specifically look for a lender that uses manual underwriting to get the benefit of a human reviewing your initial application.
Frequently asked questions
It can take anywhere from an hour or two to more than 45 days. Online lenders tend to be faster than banks, although banks that use underwriting software can also be quick.
It depends on your lender. Some weigh personal credit heavily in the process, while others consider other aspects of your personal finances. If you end up choosing a lender that caters to those with bad credit, your loan will typically be much more expensive.
The Canada Small Business Financing Program (CSBFP) offers loans that are backed by the government. These loans come with some of the most competitive interest rates on the market, but there are some restrictive requirements – such as how you can use your loan funds. Learn more in our guide here.
Anna Serio is a lead editor at Finder, specializing in consumer and business financing. A trusted lending expert and former certified commercial loan officer, Anna's written and edited more than 1,000 articles on Finder to help Americans strengthen their financial literacy. Her expertise and analysis on personal, student, business and car loans has been featured in publications like Business Insider, CNBC and Nasdaq, and has appeared on NBC and KADN. Anna holds an MA in Middle Eastern studies from the American University of Beirut and a BA in Creative Writing from Macaulay Honors College at Hunter College, CUNY.
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