The 5 C’s of SBA Loan Eligibility
Qualifying for SBA lending is no easy task, and there are some elements of your application that lenders will always review with a critical eye when determining your eligibility. These elements are referred to as the ‘5 c’s.’ save yourself time and frustration by making sure you’re a well-qualified candidate in these five areas before applying for an SBA loan.
Having a large enough down payment is a crucial piece of being approved for an SBA loan. This down payment is also known as your ‘equity injection’ or the amount of capital you’re able to invest in the business. Having enough capital on-hand is important because banks aren’t willing to cover 100 percent of your project cost. They’re reassured by knowing that you have a large personal stake in the success of the business. How much you’ll be required to put down varies by both your type of SBA funding and your business. For SBA 7(a) loans, banks often prefer to see 20 percent down for existing businesses and franchises (with a 10 percent minimum). Only the strongest of buyers and businesses qualify for the 10 minimum buyer injection.
Just as it does when you apply for any kind of financing, your credit score and credit history play a role in whether you’re approved for SBA lending. Most banks will look at both your personal and business FICO score. A 690 personal score and 160 business score are typically the minimum requirements for loan approval. Credit events such as recent bankruptcy can have a significant negative impact on your attractiveness as a borrower.
Capacity is your newly purchased business’s ability to generate income (or cash flow) to repay the borrowed debt. This formula is termed the debt service coverage ratio (DSCR), or the operating cash flow divided by debt service. Banks and other lenders use this tool to determine if a business entity is a good candidate for a loan. On one side of this ratio is the cash that you, the new business owner has available to pay back a loan in a year. On the other side is the amount of money you’re borrowing per year, plus interest. Banks will review the three (3) most recent Business Tax Returns, the three (3) most recent Profit & Loss Statements, Balance Sheets, and YTD interim P & L’s and Balance Sheets to determine DSCR. Most SBA Preferred Lenders are looking for a minimum DSCR of 1.25 and greater.
Lenders use another tool, called a debt-to-income ratio (DTI) to determine your personal-suitability for a loan. To determine DTI, tally up your monthly personal debts, including car loans, credit card payments and other debts you might have. Also include your housing expenses, like mortgage payments, property taxes and homeowner’s insurance. Divide your total monthly debts by your monthly gross income and then multiply that number (which should be a decimal) by 100 to get a percentage. Most traditional lending institutions look for DTIs no higher than 36 percent. If when calculating your DTI, you find that your income far exceeds your debts, you can expect lenders to add some of this excess income to the available cash of your business. This could be a good thing for businesses whose debt service coverage ratio’s need a boost.
Lenders look at both your personal and business character when evaluating your strength as a borrower. Most importantly, your business experience — especially in the industry of the business you’re hoping to fund — will play a factor in the eyes of lenders. However, you’re also required to provide information about events in your personal history, which speak to your personal character such as details about child support payments, criminal convictions and recent arrests.
Your personal property may be used as collateral to secure your loan. For example, the bank may take a lien against your primary residence to use as security if the loan goes into default. However, unlike the other eligibility requirements, it’s possible you may not be denied a loan if you don’t have enough collateral to secure it — as along as all other requirements are met.
Please see our blog post “How to Qualify for an SBA Loan and Purchase that Business of your Dreams”
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