Loans are one of the go-to funding solutions for both large and small businesses. But getting a loan for your small business can be a nightmare. Not only do you have to jump through countless hoops, but the chances of getting approved in the end are discouragingly low.
The loan approval rate for SMBs in big banks is only 14.9%. And at 20.6%, the approval rate in small banks doesn't look very promising either. You might have better chances with alternative lenders, but it’s still a huge gamble at a 26.6% loan approval rate.
So, what do you do when the bank, lending institution, or funder says no to your loan application? First, you need to find out why your loan got rejected. It could be any number of reasons, and the lender may not feel the need to share them with you. That’s why we’ve prepared this list of the most common reasons banks and other lenders reject loan applications. Read on and learn how to better position your business for loan-based financing.
1. Your business credit score is too low
Poor business credit is one of the main reasons for loan rejection. Business credit is a summary of your business’s financial history. It’s quantified numerically as a credit score, which represents your organization’s creditworthiness or lending risk. This is the primary metric most lenders, funders, and banks use to judge your reliability in repaying loans.
Some lenders also consider the entrepreneur’s personal credit score when evaluating eligibility for business loans. A low personal credit score may look bad on a business loan application too.
Check your business and personal credit with any of the national credit bureaus and make some effort to boost them if they are too low. Start by paying your bills on time and using accounts that report payments to credit bureaus.
2. There’s no evidence of strong cash flow
How is your cash flow? This is a strong marker of your business's financial muscle and ability to repay loans. And it’s not just a question of how much your business makes but how it manages its revenue streams and expenses. For instance, irregular earnings, random expenses, unrealistic projections, and mismatch between expenditure and income are major red flags.
Get a firm handle on your cash flow and budgeting. To build creditworthy cash flow, you might have to re-think your financial management and reporting processes or business model.
3. You're asking for too much or too little
Lenders might be too skeptical about your repayment strategy if you ask for too much money. Again, if you ask for too little (based on why you need the money), the lender might dismiss your application. Plus, the cost of servicing small loans is simply not worth it for some banks.
There's no golden rule as to how much you should borrow. Just find a sweet spot between how much the lender can give you, what you can afford to pay back, and how much you actually need.
4. The reasons for seeking a loan are not convincing
If you can’t convince the lender your business needs a loan, they won’t give you one. This might sound simple enough, but it’s not. The lender will want to know how you plan to use the money and how the loan will help the business. Your loan will probably be rejected if the lender fails to see the value it brings to the business. After all, the lender is betting on the business to get back their money.
5. Your debt-to-income ratio is too high
Your business’s debt-to-income (DTI) ratio is the percentage of gross revenue that goes to servicing debts. For example, a 20% DTI ratio means that your business spends 20% of its gross (monthly, quarterly, or annual) income on debt payments. DTI ratio basically signals how much debt you have relative to your income.
Aim for a 35% debt-to-income ratio or lower to maximize your chances for loan approval. But not so low that your business lacks a rich credit history.
6. The business is still young
It’s hard and sometimes impossible for a new business to qualify for a loan. For one, lenders are very reluctant to loan unproven start-ups. Plus, it takes time (at least two years) to build convincing business credit that demonstrates good relationships with vendors, suppliers, funders, and debtors.
7. You have a weak business plan
Besides convincing lenders that you’ll put the loaned money to good use, you also have to prove that you understand your enterprise and have a solid plan to achieve various business goals. This is best demonstrated in a business plan. A business plan defines your business’s mission and the path and resources needed to see it through.
The lender will be particularly interested in the financial side of the business plan. It must show how the business makes and hopes to continue making money and the financial challenges or risks it faces. A realistic, achievable, and efficient business plan wins you favor with lenders.
8. There's not enough collateral
Many traditional loan products and lenders require businesses to provide collateral to get approved for loans. It’s quite a long shot for small businesses to seek unsecured loans (loans requiring no collateral). Collateral could be any asset whose monetary value is equal to or more than the loan’s amount. If your business doesn't have enough valuable assets to secure a loan, the lender might reject your loan application.
In some cases, the lender will accept the business owner's, partner's, or shareholder's personal property as collateral for a business loan. This is known as a personal guarantee, and it's a great way to supplement business loan collateral.
9. Incomplete loan application submissions
The last common reason that business loans get denied is incomplete applications or submissions. As unlikely as this might seem, it's actually quite easy to skip one or two crucial steps in the loan application process. Ignoring or missing even minor details means that the loan application reaches the lender short of some vital information. Banks and lenders will also reject your loan application if it contains inaccurate or conflicting data.
It would be unfortunate to have incomplete or inaccurate applications as the only reason for your loan rejection. So, prepare all the documents the lender requires, ask questions when in doubt (don't make assumptions), and double-check everything before submitting your application.
Wrapping up
Getting rejected for a much-needed business loan can be frustrating and discouraging. But every loan rejection is a learning opportunity. You can re-examine your application, see and correct where it went wrong, and apply again with a better chance of approval.
And remember, not all banks or lenders are the same; try switching them around to find where your luck lies. Learn what different lenders demand from borrowers in order to approve their loans, and gauge how well your business stacks up against these requirements before applying. Maybe a loan is not even the right solution for your business anyway. There might be other financing products you haven’t considered that would suit your business better than taking out a loan.
Fortunately, you don’t have to painstakingly scour the internet and contact every bank and lender to do this. You can compare different lenders and financing products with just a few clicks, thanks to Lendzero.
Lendzero conveniently lists all the financing products available to your business on a single application. We also run all the pre-qualifying checks and pre-negotiate with lenders on your behalf to ensure you get the best possible financing deals. Start today and explore financing possibilities like never before.
