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5 Important Questions to Ask Before Applying For a Small Business Loan

5 Important Questions to Ask Before Applying For a Small Business Loan
5 questions to ask before you apply for a small business loan. / Credit: Questions marks image via Shutterstock

Whether you are starting a new business or looking to expand an existing one, you might need a small business loan to accomplish your business goals.

According to statistics from Biz2Credit, despite a nearly 20 percent increase in lending at large banks in 2014 compared to 2013, small business loan application approval rates dropped from 19.1 percent to 18.8 percent from February to March. However, small bank and credit union small business loan approval rates for the same month-to-month rate inched up from 51.4 percent to 51.6 percent and 43.3 to 43.6 percent, respectively.    

Whatever the size and type of lender you choose for your small business loan, here are five questions  lending and small business experts say you should ask before signing your loan application.   

"It would be wise to ask banks about their specific requirements before applying," said Patricia J. Kratz,  lender relation specialist at the U.S. Small Business Administration's Philadelphia district office. "Many [lenders] will let you know the minimum credit score they require, the cash flow you need to show, and other qualifying factors." 

While a personal credit score of 800 is considered ideal, a range of 680 to 720 is more in line with what banks generally accept, Kratz said. Credit scores significantly below that do not necessarily disqualify applicants, but do need an explanation for the score and what steps the business has put in place to prevent the situation from recurring.

The greater the applicant's business cash flow-to-debt ratio, Kratz said, the more favorably a bank looks upon the loan application. The generally accepted cash flow-to-debt ratio is 1-to-1. However, "some banks want $1.30 in cash flow, [to $1 in debt] as a cushion, so you can see it as a moving target," Kratz said.

Kratz recommends small business owners ask the question: What are the standard terms and conditions? This question helps business owners gain information about the loan other than just the interest rate. Applicants can learn if a loan has a prepayment penalty, if and when a lender can demand full repayment of the loan's outstanding principal, and if a grace period exists.

Comparison shopping for a loan may pay off because different lenders have different loan terms. The SBA prohibits prepayment penalties on their loans with an amortization [schedule] under 15 years, Kratz said. "Some banks are willing to negotiate [prepayment penalties], most will not."

Editor’s Note: Considering applying for a small business loan? If you’re looking for information to help you choose the one that’s right for you, use the questionnaire below to have our sister site, Buyer Zone, provide you with information from a variety of vendors for free:

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This question, according to the SBA, helps determine if there is a grace period of 10 of 15 days, for example. A grace period helps borrowers avoid a late fee after the loan's monthly payment due date. Small business owners can also determine if and how a lender can demand full payment based on missed payments, if you file for bankruptcy, or if you find your business in the midst of legal action.

Robert Potter, executive vice president of Lone Star Capital Bank, said it's also important to ask what nonrefundable fees or charges accompany the loan request.

Potter said that whether or not you are approved or go through with the loan, commitment fees, collateral appraisal costs and credit report fees are not refundable much of the time from lenders.     

Alma Valdez-Brown, loan officer for Accion Texas, recommends asking your loan officer if he or she will be looking at your personal credit [report].

Valdez-Brown said that lenders still look for a personal guarantor. Whether a small business owner operates as a sole proprietor, a corporation or any other type of organization, his company requires a personal guarantor. However, Valdez-Brown said that a lot of people are under the impression that the decision will be based on business credit. Paying attention to your personal credit, along with your business credit, is very important.  

Valdez-Brown said most financial institutions require that anyone with 20 percent or more ownership in the business be on the loan application. If only one person on the application has poor credit it may negatively impact the approval process.

Originally published on Business News Daily.