When you own and operate your own business, there does come a time when you need funding. Perhaps you’re looking into buying property, maybe even buying out a smaller firm. Going to the bank for a loan or line of credit can undoubtedly seem a daunting task. Beyond how long it takes, the level of scrutiny with which underwriters examine your loan application is intense.
There are many key factors that lenders do look at closely upon evaluating whether or not you qualify for financing. There are five key elements, or what you may call the 5 C’s, that weigh more heavily than other pieces of your application. Below we offer a breakdown of what those 5 C’s are so that you can be better prepared and hopefully get the funding you need for your small business.
Understanding the 5 C’s of Credit
Known throughout the industry as the 5 C’s of credit, these are merely factors that banks and lending institutions look at most closely when reviewing loan applications for businesses. These elements help them to determine whether or not your company poses an acceptable risk.
Understanding these 5 C’s puts you in a better position as far as getting your application ready as well as being able to answer the pertinent question relative to these key ingredients.
As is commonly known, collateral represents that which the applicant intends to put down to secure the loan amount. Lenders like to see this as it helps assure that if there is some repayment problem, they do always have the collateral on which to fall back. Which means, if you do default, you could very well lose any collateral that was part of the deal.
Such loans that are backed by collateral are known as secured loans. For those who have less than ideal credit scores, supplying enough collateral may be the only way to get the money you need. In this way, there is less risk on the lender’s part, and they consider the deal a much safer one.
Also, with secured loans, the interest rates do tend to be a bit lower. This, in turn, cuts down (sometimes drastically) on the amount you will pay back over the life of the loan.
Understanding capital seems fairly easy…it is essentially the total value of your assets minus your liabilities. However, there may be a little more to it when dealing with your business and the loan process.
As far as getting bank funding, your capital is what you need to put toward the loan. In other words, think of it in terms of your deposit on the total amount borrowed. The more money you can put down, the higher the percentage you can come up with, the more confident the lender will be as far as your capacity to repay. So of course, your chances of getting approved go up as the capital increases.
The conditions of your loan encompass many factors. In essence, it’s an umbrella term denoting the loan details, so things such as amount, interest rate and the length of the loan.
However, the term conditions can also apply to those factors which characterize you and your business. For instance, do you have a lengthy credit history? If not, then again, coming up with more money to put down and more collateral can help get you approved.
Take a look at the interest rate. With small businesses especially, this can genuinely impact what type of loan you get and whether or not you even opt to get a loan in the first place. Some lines of credit with larger institutions may have rates of 3-5%, while SBA loans could be somewhat higher than that.
Capacity refers to your ability to repay the loan you get. So before filling out any application take a good long look at your business finances, see where you stand, what money is going out, what money will imminently need to go out. You do not want to bite off more than you can chew.
Understanding your debt to income ratio is incredibly essential before applying for a small business loan. Mostly this is measuring your income against debts and expenses.
Most banks like to see a DTI of 35% or less. If you are up above 42% your odds of getting approved are significantly narrowed. This is why you want to strive for that under 35% mark.
DTI = recurring monthly liabilities / gross monthly income
Plug in the numbers, see where you fall; perhaps take a step back and see what you need to do to lower that percentage.
This is far more abstract criteria—and yet, still a critical one. Taking into considerations things like FICO score, customer reviews, and RiskView reports, banks can get something of a handle on who you are and what your firm represents.
Apparently, they are looking for positives here. They want to know that they are lending to a company that is honest, transparent and that services its clients well. Maintaining a good credit score can certainly help with character.
Some of the critical things that lenders do weigh when assessing your company’s character: FICO (at least 550), Payment history, Any collections/liens, and Years in business.
So Why Are the 5 C’s Important Anyway?
It’s all about risk. The riskier your company seems, the less apt banks will be to fund you. It’s a no-brainer really, the less risk you pose, the more likely that you will be qualified. Moreover, how do they measure that risk? In part by relying upon these 5 C’s.
Understanding what the 5 C’s is all about and how to work on improving them is your best bet as far as ensuring that you get financing. Banks do not like to gamble—in fact, they run from it. So know your credit score, understand DTI and how to get it to where it needs to be. Make sure you do your utmost to keep happy customers and in turn get satisfied reviews. Put yourself in an optimal position for procuring the money your small business needs.