Top Reasons Why Your Business Loan Application May Have Been Denied
by Arnab Dey Loans & Credit 21 June 2023
When applying for a loan, many business owners feel confident that they will be approved. However, if you’ve ever received a denial letter, you know it can be a frustrating and confusing experience.
Lenders want to ensure they will receive their money back and are always looking for any potential red flags – some of which may not be as obvious as expected.
There are many reasons why a business loan may be denied, and entrepreneurs need to comprehend the most common ones, at a minimum, to increase their chances of being approved in the future.
Not Enough Collateral
One of the top reasons why many business loan applications get denied is insufficient collateral (that is, the assets a borrower pledges to a lender as security for a loan, such as equipment or real estate). When the borrower faces loan defaults, the lender might seize its collateral to recover their losses, minimizing their risk.
If a borrower doesn’t have enough collateral to protect the loan, the lender may deny the application. Sometimes, a lender may be asked to authorize additional collateral or use a co-signer to approve the loan. The amount of collateral required varies depending on the kind of loan and the lender’s policies. A secured loan may require the borrower to pledge a specific asset, while an unsecured loan doesn’t require collateral but may involve higher interest rates and stricter eligibility requirements.
Credit Score Issues
When you start looking into the nitty gritty of how to get a small business loan for your venture, you’ll see that having a good credit score is an essential element. When you apply for a business loan, the first thing lenders look at is the business owner’s credit score. A credit score refers to a numerical representation of a person’s creditworthiness, depending on the credit history they share.
If a business owner has a low score, it can indicate a history of not paying bills on time, defaulting on loans, or having high debt levels. These factors can thus make a lender hesitant to approve a loan application. The score you need depends on the kind of loan and the amount requested and can also vary generally from lender to lender. If your credit score is below the minimum requirement, you may be denied the loan or offered one with a higher rate of interest and less favorable terms.
Too Much Debt
A high DTI or debt-to-income ratio is a common reason why business loan applications get denied. DTI ratios measure how much of an individual or venture’s income goes toward paying debts. When a lender sees a high DTI ratio (usually considered above 43%), they may be concerned that the business may be unable to make loan payments on time.
This is because a high DTI ratio means that a significant portion of income is already allocated to paying existing debts, leaving less money available to make loan payments.
Your business loan application may be denied due to inadequate cashflow. Lenders need to see that a business has enough cash coming in to pay back the loan. If a business has a history of negative cash flow or generally inconsistent revenue, it may be considered too risky to lend to.
Lenders typically look at a business’s cash flow statement to assess its ability to repay a loan. This statement shows the inflow and outflow of cash over a period, such as a quarter or a year. If a business has a negative cash flow, it’s spending more money than it brings in, which is a red flag for lenders.
Another factor that lenders consider is the debt service coverage ratio (DSCR). This ratio measures a business’s ability to pay its debt obligations. If a business’s DSCR is below 1, it is not generating enough cash to cover its debt payments. This undoubtedly makes lenders hesitant to approve a loan.
No Solid Business Plan
If you don’t have a solid business plan or the document you have seems inconsistent, you might also have your loan application denied. A quality plan outlines a company’s goals, strategies, and financial projections. It’s a crucial component of a loan application as it shows the lender that the business has a clear direction and a solid plan for growth, with reasonable expectations and a good understanding of the current strengths, weaknesses, opportunities, and threats of and to the venture.
An inconsistent business plan can be a red flag for lenders as it indicates the owners may not clearly understand the business market, competition, or financials. A poorly written or incomplete business plan can also suggest that entrepreneurs don’t have the necessary experience or expertise to run a successful operation.
Getting approved for a business loan can be a complex process. However, by understanding why loan applications are commonly denied and taking steps to address these issues, business owners can increase their chances of securing the financing they need to succeed.