Small Business Loans 101: The Application Process (Part 2)
Note: this is part two of our three-part Small Business Loans 101 series. Head over here for last week’s article: Finding the Right Lender.
After you’ve found a few lenders you may be eligible for, it’s time to start applying for loans.
Although all have their own process, most lenders appear to have adopted the same three-part application. Understanding how these applications work will allow you to navigate the whole process with ease, and make some comparisons between lenders on the way.
Here’s everything you need to know about effective loan application.
The Application Process
Every lender’s application is a little bit different, but most follow the same three stages: prequalification, verification and underwriting, and funding.
In the prequalification stage, you will need to fill out detailed information about you, your business, your business’s finances, and what you’re looking for in a loan. The information at this stage is normally unverified, though of course, you should still be as accurate as possible.
Some lenders will also allow you to complete this stage informally over the phone.
An underwriter, or, often, a computer, will look at your application and determine if you’re qualified to receive funding.
If so, at this point many lenders will present an estimated loan offer to you. This offer will detail information about your potential loan, including your borrowing amount, interest rate, fees, term length, and size of periodic repayments. Ideally, the quote will also include information to help you compare loan offers, including the APR and/or the cents on the dollar cost.
If you’re still deciding between a few lenders, get an estimated loan offer from each one to easily compare your options.
Contrary to what many people think, being “prequalified” for a business loan does not mean that you are necessarily approved for funding. To be officially approved, you need to complete the next step.
Verification and Underwriting
Before actually giving you money, the lenders will have to verify your information. This step primarily involves supplying documentation about yourself and your business, so lenders can be sure they’ve offered you a deal that will fit your business (and that you’re not lying to them).
During this stage, lenders may ask for financial documentation. For a list of what your lender might require, check out the Required Documents section.
Many lenders also require you to complete steps to verify your identity, which may include answering basic personal questions over the phone, or having a code mailed to your house.
At the end of this process, you will be presented with a final offer. In some cases, this offer may be different from the quote you received during the prequalification stage, so it’s important to go over all the information to ensure the offer is something you want. As always, before signing a contract, read the fine print.
At this point, the only thing left to do is to get funded!
After you’ve accepted an offer, the lender will send the money to your bank account. Normally this happens via an ACH transfer, which means the money will take one to two business days to transfer between banks.
Soft vs. Hard Credit Checks
Almost every lender will check your personal credit score. Often, they’ll check twice—first using a soft inquiry, and second using a hard inquiry.
Soft inquiries are primarily used to verify your identity and get a preliminary idea about your credit situation. This type of inquiry does not affect your credit score.
Hard inquiries, on the other hand, lower your credit score by a few points. Lenders who request a hard inquiry can see your full credit history, but are not allowed to perform a check without your permission.
Most lenders perform a soft inquiry during the prequalification stage, and only perform a hard pull if you choose to continue on to the verification and underwriting stage. As such, you can get quotes from a few different lenders for comparison before deciding on an offer.
However, because every lender’s application process is a little different, it’s advised that you ask the lender upfront when they perform a hard check to preserve your credit score, or you might discover unexpected credit checks on your history.
Documents Lenders Require
To get an idea about your business’s financial health and ability to repay debts, the lender will ask to look at certain financial documents.
Lenders don’t all ask for the same documents—some will only ask to see a few documents, others will ask to see everything on the following list and more. As annoying as it can be to track down all this information, be aware that the more information you have to submit, the lower your interest rates and fees will be. Lenders that require very few documents tend to have very high fees.
Your lender might ask for documents like these:
- Proof of identity
- Recent business bank statements
- Recent business credit card statements
- Business tax return
- Personal tax return
- Profit and loss statement
- Balance sheet
- Debt schedule
- A/R aging
The faster you can hand over the documents requested by your lender, the faster the application process will go, and the faster you’ll be able to access your borrowed funds.
How to Compare Small Business Loan Offers
Ideally, you’ll get a few quotes from a few lenders before settling on one to ensure you’re getting the best rates and the best product for your business possible. These quotes should detail everything you need to know about your loan: your interest rate, fees, APR, and term length.
When deciding between loan products, there are four factors you must take into consideration.
Type of Loan
Different types of loan products are suitable for different uses. Products with short term lengths, such as short term financing, invoice financing, and lines of credit, are normally better for working capital needs. Longer term products, such as medium or long term loans, are better for business expansion or refinancing purposes.
Annual Percentage Rate
It’s important to know your interest rate and fees, but to understand the cost of borrowing you need to know your annual percentage rate (APR). This number, written as a percentage, encapsulates the total cost of borrowing over the course of a year, including your interest rate and any fees associated with borrowing.
For example, a loan that has an interest rate of 15% might have an APR of about 17% because of extra fees added onto the process. So, if you were comparing that loan to another with an interest rate of 15%, but an APR of 16%, you would know which offer is truly better.
For more information about APRs, check out this article. Be aware that loans with term lengths shorter than a year tend to have very high APRs; if you’re comparing loans of that type, give this article a read.
Cents on the Dollar Cost
The cents on the dollar cost communicates the cost of the fees for every dollar borrowed. While APR communicates the total cost of borrowing over the course of one year, the cents on the dollar cost communicates the total cost of borrowing… period. This number is more useful when comparing loans that carry shorter terms, though it’s also useful for any merchant concerned with saving as much money as possible.
Calculating the cents on the dollar cost is easy: divide the amount of fees by the amount you’re borrowing. For example, if you’re borrowing $100K, and you have to pay $20K worth of fees, you’re paying $0.20 for every dollar borrowed: $20,000 / $100,000 = $0.20.
This number can put business loans with differences in loan size, structure, and term length on an even playing field for easy comparison of overall cost.
APR and dollar-for-dollar cost mean nothing if you find you cannot actually make the periodic payments. A quality lender will not give you periodic payments that are overly burdensome, but there are other reasons for favoring larger or smaller monthly payments.
You might opt for larger payments because you’ll be able to discharge your loan more quickly and save money. On the other hand, you might choose smaller payments because your cash flow fluctuates and money will be tight at times.
Instead of repaying on a monthly basis, some lenders require repayments on a daily, weekly, or bi-weekly basis. If you’re comparing loans with different repayment intervals, calculate how much you would pay each month for easy comparison.
The application process can take anywhere from a few hours to a few days, primarily depending upon the amount of documentation you have to provide. Know what to expect, be as prepared as possible, and you will be able to speed up your loan process and get access to that sweet, sweet capital.
Want to know best practices for paying off your shiny new loan? Check back next week for part 3 of our Small Business Loans 101 series: Repaying Your Loan.