Understanding How Alternative Lenders Assess Small Business Loans
After the last great recession, lending for small businesses has changed a great deal. Traditional banks and credit unions began finding it very difficult to loan money to small businesses with limited track records, and alternative lenders arose to fill in this economic gap. When dealing with these types of lenders, there are four key items uses to assess the viability of a loan to a small business owner.
The Credit Check
When you try and borrow money to finance your small business operations, it is your personal credit score that plays the largest role in how much and under what terms a lender can loan you money. This is especially true if you’re the sole proprietor. There are alternative lenders willing to work with people with subpar credit scores, at times, as low as 500. However, if you can bring a score of over 720 to an alternative lender, you will have set yourself up well for ideal borrowing terms.
Banks are certainly still amenable to lending to people with these very high credit scores, but that doesn’t mean that ideal borrowers should rule out alternative lenders. If you need money quickly and with more flexibility in your loan terms, alternative lenders may prove a viable option.
Alternative lenders may only loan money to risky borrowers through very high interest programs that utilize an Automated Clearing House or Merchant Cash Advance model. These models can charge as much as 80% APR, which is impossible for a business to sustain over the long term. They should only be used for very short term, emergency cash flow shortages.
What Type of Collateral Can you Provide?
Alternative lenders carefully consider your existing assets when deciding what type of loan they will extend to you. This lets them know that if you default on the loan there are assets that can be sold in order to satisfy the debt. From the perspective of the business, any equipment or deposit history the business may have can be assessed as collateral. However, there are also personal assets that will be taken into account.
The largest personal asset for many individuals is their home equity. Alternative lenders will sometimes look at offering a home equity line of credit that a person may use to help finance their small business expenses. Additionally, if you have investment properties you may be able to refinance them in order to access some additional cash.
Banks, at times, are not very trusting of start-ups, that is to say a company that has been in business for less than two years. Normally they require a history surpassing this point in order to extend traditional business financing. However, in as little as three months of operations a start-up may be able to secure financing from an alternative lender. The general principle still applies in that the longer you stay in business, the more flexibility you will find when seeking business loans.
If you still fall into the start-up category and need a loan, recognize that you’ll be facing higher interest rates. If you must borrow during the time, try to rely on short-term financing that you can repay quickly rather than major loans. Build some assets and business history, and within two years you will have access to some much more attractive financing options.
At the end of the day, profits speak louder than any other one element that a lender looks at. If you can show conclusively that your business has a pattern of generating reliable income month after month, most alternative lenders will be able to find at least some sort of lending product that will work for you.
Lenders use a variety of tools to assess exactly how much money they will lend a business based off their monthly income, but an important factor is the average amount actually in your bank account over a set period of time. However, loans made on this model also fall into the Automated Clearing House and Merchant Cash Advance categories, meaning that they are very high interest loans.
Typically, these are repaid by an automatic withdrawal from your account on a regular basis to pay back the loan. This requires that you keep your income at a consistent level in order to consistently be able to meet your obligations.
The ultimate message here is that not meeting the criteria of the big banks should not be seen as a roadblock anymore. There are countless alternative lenders in the marketplace that provide opportunities for you to find the small business funding that you need. However, remain cautious and remember that not all small business loans are created equal. Make sure you understand the terms of repayment and determine that the available cash flow will benefit your business more than the interest payments will harm it.
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