Q&A: How Banks Evaluate Loan Requests
Discover what underwriters care about when evaluating your application.
Loan applications ask for a lot of financial information – so much so that it is tempting to skip a step or leave something blank. In this Q&A, Union Bank Underwriter Diana Harb explains what information she looks for in a loan request.
Q. What do you look for in a loan application?
A. When an underwriter reviews a loan application there's one key focus. We need to understand how the customer will be able to repay the loan. The combined cash flow also needs to be reviewed to know if the business is profitable. Other sources of repayment show profitability, such as collateral, owner liquidity and tangible net worth. Again, this helps to determine how the bank will be repaid.
Q. Do some documents in the loan package matter more than others?
A. Small business lending analysis is highly focused on tax returns. Tax returns are the most common measure of a business, whereas accrual financial information is important for larger credit requests. However, during the first four months of the year it is common for applicants to not have the most current tax returns. It's best to tell the bank that your tax return is being prepared and that you will provide it when it's completed. In the meantime, you should include an interim financial statement created by a credible source, such as your CPA.
Q. What sends warning signals about an application?
A. Derogatory or poor credit, heavy utilization of debt such as credit cards, limited owner net worth and liquidity. These often indicate cash flow demands that the bank has not identified. It also indicates a limited ability to handle business fluctuations.
Q. What other "best practices" or models do you use when evaluating an application?
A. Well, our most important practice is to receive a complete loan package. If financial information is more than five months old, interim financial information will need to be reviewed with a focus on understanding large items on the balance sheet or income statement to see if anything has materially changed from the previous year. If the guarantor owns real estate, the real estate schedule with the tax returns will be reviewed to explain any differences.
Q. What factors do you consider regarding loan repayment?
A. The purpose of the loan is critical. We want to know what's happening in the business to drive the need to borrow. For example, if a borrower requests an increase in a line of credit, is it because sales are increasing or because accounts receivable are past due?
Q. How are payment terms and the length of the loan decided?
A. That is heavily based on loan purpose, collateral, cash flow and dollar amount.
Q. If the loan is to buy equipment, what is the useful life of the equipment being purchased or the collateral?
A. Generally, five years is the maximum term for unsecured or equipment financing.
Q. What about commercial real estate loans? What is that process like?
A. The business should be established for at least three years. A copy of the purchase contract and the most recent tax assessment for the property may need to be provided as well. An appraisal may also be done to determine the property value. Generally, commercial real estate loans under $100,000 have faster turnaround times. If the borrowed amount is more than $100,000, financial documentation will need to be provided, including the two most recent business and personal tax returns. The loan can be used to build, purchase or refinance an owner-occupied property or expand or remodel existing facilities.
Q. Do you have any helpful hints for getting a loan approved?
A. Take the time to get to know your lender. Banks want to know what is happening in your business because it helps them do the best job possible for you. Underwriters often have plenty of questions about your applications, so don't be surprised if they contact you to ask about your business. Be ready to provide as much information as possible.
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