The credit assessment process is an integral step to determining whether you may qualify for a loan. Today we’re pulling back the curtain on lender credit requirements, often referred to using the industry term “credit box” to help you understand the factors that go into determining a borrower’s creditworthiness.
We believe that with a robust understanding of why lenders operate the way they do, business owners can make more informed preparations for their business loan applications.
While credit criteria varies from lender to lender (and product to product), most lenders will use the following areas to determine whether a borrower qualifies for a loan:
Credit criteria help lenders determine the risk so they can make informed borrowing decisions. These credit criteria are especially important for unsecured loans, where there isn’t any collateral guaranteeing the loan. This includes loan types like a business term loan. With secured loans, the lender can rely on the worth of the collateral in case of default. This includes products like an equipment loan or a commercial mortgage.
Lenders look at the borrower’s ability to repay the loan based on credit reporting for the individual and the business. They then look for data to support the lending decision—usually from the business financials or bank statements. Lenders also review a borrower’s history of loan repayment, their background, and the volatility of the industry in order to assess risk.
In turn, the risk associated with the loan will likely affect the cost of capital. The greater the risk for the lender, the higher the cost of capital. The lower the presumed risk, the lower the cost of capital will be.
The risk associated with a loan can change when a single factor moves. In 2020, for example, the volatility of the industry increased for businesses that had to weather forced closures and pandemic-reduced demand. As a result, the loans a borrower could secure, the loan size, and the cost of borrowing likely changed… even if there were no other changes to your business.
As market volatility reduces and business reopens, we can expect that lenders may release some of the stringent underwriting criteria that’s been adopted over the past year or so. The great news is that we have some sense of how they might approach credit decisions and underwriting criteria.
We can expect lenders to consider the following metrics:
Time-in-business will likely remain important, as lenders have seen the way that long-tenured businesses have been more likely to stay open and have the tools to continue generating revenue through the unexpected (you know, like an unprecedented global pandemic).
The pandemic has changed everything—business lending included. Here’s what we can expect in the near future: