OCTOBER 9, 2017
Too many American business owners don’t have the capital they need to grow because they fear lenders will deny their credit applications.
Even when facing financial difficulties, most businesses shy away from debt. A 2016 survey by the Federal Reserve bank, reported that 76 percent of businesses used their own funds to overcome financial challenges. Only 44 percent of businesses facing financial difficulties got a loan.
WHY ARE SO MANY BUSINESSES CAGEY ABOUT APPLYING FOR A LOAN?
About half (51 percent) the businesses that needed additional funding did not get a loan because they were avoiding debt. The other half (47 percent) are either discouraged by previous credit denials or think it’s too difficult or expensive to apply. For instance, 39 percent of discouraged businesses don’t apply for a business loan because they think their credit score is not good enough to qualify.
Are businesses justified in their fears of credit denial?
Yes and no.
According to the 2016 Small Business Credit Survey, only 53 percent of businesses get approved for the entire loan or line of credit they apply for.
With those odds, you can see why so many business owners don’t bother.
The good news is it has never been easy for businesses to search for loans and check whether they qualify. There are several sites that offer business reviews and credit tools to see what loans they qualify for without hurting their credit.
How can businesses improve their chances of approval?
There is a lot a business can do to tip approval odds in its favor but let’s focus on two things:
WHICH LENDERS HAVE THE HIGHEST RATE OF APPROVAL?
Community development financial institutions, also known as CDFIs, have the highest approval rate (77 percent) for businesses with an annual revenue of less than $1 million. Larger firms with an annual revenue of more than $1 million have better results (84 percent) with online lenders.
CDFIs are mission-driven financial institutions that are certified by the U.S. Department of the Treasury’s CDFI Fund. They include credit unions, banks, loan funds, and even venture capitalists that have the goal of serving low-income communities.
The catch is not everyone qualifies for a CDFI loan, and there may not be a CDFI in your area. In the Federal Reserve survey quoted above, only 143 businesses had applied for a CDFI loan compared to 1,829 businesses who applied for a small bank loan and 604 that applied with an online lender.
If you are a small business and don’t qualify for a CDFI, which includes most businesses, small banks and online lenders offer good chances of a loan approval. If you’re a larger business (more than $1 million a year in revenue) you have better odds with an online lender (84 percent).
WHICH LOAN TYPES HAVE GOOD CHANCES OF APPROVAL?
The purpose of the loan has a big effect on its approval rate. Auto or equipment loans have the highest approval rates (79 percent), followed by cash advances (72 percent), mortgages, and lines of credit (68 percent).
The reason auto, equipment loans and mortgages have higher rates of approval is they are usually secured by the assets bought with the loans, which make them less risky to lenders. Cash advances have the highest approval rate for unsecured loans, but their interest rates are usually high – which explains why only a small number of the businesses surveyed by the Federal Reserve applied for cash advances.
Lines of credit and traditional business loans are the most common type of loan for businesses. However, lines of credit have a 10 percent higher rate of approval. Small Business Administration loans usually offer the lowest interest rates, but they have a 55 percent approval rate and can take several weeks or even months to process.
There are the two tips you need to remember If you are looking for business capital and you want to maximize your chances of approval:
Businesses with an annual revenue of less than $1 million, may want to check if they qualify for a CDFI loan. If you don’t, apply with an online lender or a small bank. Businesses with an annual revenue of more than $1 million have much higher approval rates with online lenders.
Auto and equipment loans and mortgages have higher approval rates but they require you to place your assets as collateral. Cash advances have high rates of approval but the interest rates are steep.
Lines of credit also offer high approval rates but the interest rates are much cheaper. Another benefit is you don’t need to borrow a lump-sum, just what you need.
However, SBA loans and traditional loans may be a better option for businesses that have excellent credit and don’t mind waiting a few weeks for funding.
WHAT TO DO NEXT?
Once you decide what type of loan and lender you need, it’s time to check the eligibility criteria, fees, funding timeline, and rates of each lender. These can vary widely from lender to lender, so investing a little time now can save you a lot of money and frustration in the long run.
Andrew Latham is the content editor at SuperMoney, a financial resource that has helped millions of people get smarter about money. SuperMoney helps consumers compare financial products and services by providing unbiased reviews and guides. SuperMoney can also be found on Facebook and Twitter.
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