What Is the Loan Underwriting Process?
A loan underwriting process is used by a lender to evaluate a borrower’s eligibility for a loan based on an analysis of their credit, capacity, and collateral, and for what loan amounts, interest rates, and repayment terms a borrower qualify for. The lender compiles a list of essential documents to verify borrowers’ identification, credit history and assesses the financial health— including revenue, cash flow, equity investment, liquid assets, and other risk factors.
Understanding the loan types and attached terms may seem like a never-ending task especially when you’re new to applying for a loan. Whether you need a small business loan or a mortgage for your home, getting ready for the loan underwriting process is the key, and that involves a lot of paperwork and intricate process.
Understanding the loan underwriting process can be a valuable endeavor just like understanding your financing options. Lenders use this process to decide whether they approve a loan application or not. And, if you have an opportunity in the loan underwriting process, its best to get prepared in order to improve your chances of getting a ‘YES’ on your loan application.
Borrowing can be an intimidating undertaking, especially for startups. While getting into the financing, it’s best to have realistic assumptions of what’s involved in the process so as to make an intelligent sound decision about the future of your business. Understanding a loan underwriting process is the first step towards securing a loan.
Commercial Loan Underwriting
A commercial loan underwriting process differs slightly from standard business loan underwriting. In a commercial loan underwriting, the process assesses borrower’s personal as well as business finances to ascertain eligibility. That being said, the commercial loan underwriting process will be a more detailed, paperwork-intensive, and laborious process.
Whether you need a fast loan for working capital or equipment financing for renovation or upgrades. it’s valuable to understand how your eligibility is gauged. No matter what loan type you request or choose, the steps will always be the same: you inquire, make a loan application and provide needed documentation. Then, you’ll be evaluated for an offer, and finally, have the best funding option based on your financing needs. This is how a commercial loan underwriting process started.
Itinerary for the Underwriting Process
The timeline for a small business loan underwriting process varies largely based on the loan type and amount along with the necessary documentation you’re applying for. Moreover, your speed of documentation gathering plays an important role in the underwriting process. For instance, term loans can be approved quickly in few business days, while a bank loan or an SBA loan takes weeks and sometimes months to approve, particularly if you dawdle on gathering the essential documentation.
Step 1: Evaluating Qualifications
The first step in the process involves a conversation with a lender generally over a phone call. Unless you’ve provided basic information about yourself and your business in the loan application, you’re required to give an overview of your business financials and purposes. Using this information, the lender will conclude the best small business loan options for which you’re likely to qualify for based on your business objectives. Here is a list of few questions that a lender might ask:
- What is the nature of your business?
- How much amount of funding is required?
- What is your plan to use the funds?
- Does your business have any existing debt?
- What is your personal credit score?
- How much revenue is your business generating annually?
- How quickly your business requires money?
- What are your expectations about the interest rate and repayment terms?
Once you answer all these questions, you’ll most likely get a recommendation on the most suited loan option based on these answers. Before getting into the underwriting process, take time to analyze how the recommended financing options will conform to your future business plans.
Step 2: Concluding the Loan Application
Once the loan options look promising for your business, the next step is to conclude your loan application by planning and understanding your business’s financial goals to make the small business loan underwriting process serene. Fill your loan application by providing your credentials such as credit history, time in business, and annual revenue.
Step 3: Compiling Important Documentation
Compiling your important documentation is your next step in the loan underwriting process. The requirement of these documents will vary from lender to lender as well as the loan product you’re applying to secure. In the case of alternative lenders, your application is presented to different potential lenders who will require different documents for their loan underwriting process, based on the loan type they offer.
The best thing about working with alternative lenders is the least requirement of paperwork in order to secure financing. Moreover, the underwriting process for many alternative lenders only requires access to the accounting software to get the needed information. Here is the list of documents you have to provide for different loan products:
- For Short-Term Loans – Your driver’s license copy, voided business check, ownership proof, credit history, three months of business bank statements and personal tax returns.
- For Invoice Financing – Accounting software comprising invoicing records.
- For Equipment Financing – Good reputation, voided business check, driver’s license copy and a quote for the equipment.
- For Merchant Cash Advances – Your driver’s license copy, a voided business check, and business bank statements for four months.
- For Short-Term Lines of Credit – Three months of accounting software records
Underwriting Process For the SBA Loans and Bank Loans
If you’re approved for an SBA loan or a traditional bank loan, you’re likely to gather a lot of paperwork. But, it’s worth compiling that additional documentation including the following:
- Your certificate of good standing
- Tax Statements for the property, business, sales, and others
- A Business brief
- Business licenses, permits, and approvals
- Six months of payroll records
- Real estate title deeds
- accounts receivable
- Business leases
- Personal real estate title deeds as collateral
- Disclosure of any unfavorable governing, tax, or enforcement actions
- Disclosure of any liens against business property
- Patents, copyrights, and other intellectual property rights
Getting approval for an SBA loan or a bank loan is a time-intensive and paper-intensive process. And the lenders may ask for more documentation than those mentioned above—because they want to ensure they’re not accepting redundant risk.
But, if you’re in search for lower interest rates with longer repayment terms, its worth to try the complicated business underwriting process with these loans.
Step 4: Acknowledging Underwriter’s Follow-Up Requests
There could be a possibility that you might have neglected the information crucial to procuring a small business loan. Similarly, some lenders might require some additional documents if they’re unable to foresee the clear picture of borrowers and the potential risk they’re considering.
It might feel infuriating when a lender comes back for more documentation especially after you’ve done everything already. Remember, a follow-up request from the lender isn’t unusual, and doesn’t mean that you’re getting denied on the loan! Be confident and attentive whenever a follow-up request is made.
Step 5: Obtain Final Loan Offers
Again, based on your lender and the loan product, you might get funding in days or could be hanging in for a few weeks or even months. After you’ve quickly done with the application process and have the essential documents ready, you’ll know the financing options available and choose from them. Its time to decide which loan option works best for you, and that initiates the small business loan underwriting process.
How Traditional Loan Underwriting Process Works
Traditionally, lenders used different approaches and pieces of information to estimate the risk of making a loan decision. They usually request a lot of paperwork to approve or deny a loan application. The only downside of the traditional approach of the underwriting process is that approval was based on the lender’s decision and not technology. And, a lender decides to approve or deny could make it lengthy and subjective for both the borrower and the lender itself.
How Latest Loan Underwriting Process Works
With the advancement in technology, lenders are using the latest technology and human expertise to make financial decisions. Whether it’s a fintech or peer-to-peer technology, there are many ways in which lenders are making loans easier for borrowers, and painless to pay off, with a smooth experience overall. They use specific measures to examine the credit risks – making the business loan underwriting process much easier.
Here are the specific measures lenders consider while evaluating the potential credit risk:
- Borrower personal and business credit scores (score of 600+ is considered good)
- A cash cushion to avoid insufficient-fund penalties and overdraft fees
- Positive cash flow statement of four months
- The minimal current debt load
- The loan amount
- A borrower ability to repay
How to Prepare for the Loan Underwriting Process
Before you make a loan application, some additional measures can help position your small business favorable to the lender. By making easy adjustments in your day-to-day processes beforehand can help you get loan approval easily. These factors won’t guarantee your approval but will influence the lenders to perceive your business as financially stable. Here are a few things you need to have a grasp on:
- Business Checking Account
- Frequency of Deposits
- Minimum Bank Balance
- Annual Revenue
- Cash Flow
Business Checking Account
Having a business checking account is necessary for business. If you have a business checking account along with your personal account, a lender will perceive you’re serious about your business and its finances.
Frequency of Deposits
If your frequency of deposits is consistent and foreseeable, you’ll be considered stable. This can be achieved by creating a flexible payment plan for suppliers and major clients to ensure frequent deposits into your bank account. You can also improve your banking habits by simply transferring money from other sources into your bank account frequently. They want to see an active business account.
Minimum Bank Balance
Maintaining a minimum balance as a cushion into your bank account is another way to improve your chances of approval. Having an average daily balance of $2,500 over the last three to four months is suggested well. Having this cushion can help you manage your cash flow flux.
Annual Tax Write-Offs
While preparing for the future business financing needs, get your tax write-offs in order by discussing it with a tax specialist. By not reducing much on your annual taxes, you can improve your cash flow for the lenders.
Plan strategically and apply for funding during your peak season when you have the most stable cash flow and your business’s financial status will appear worthwhile to lenders. While preparing for the small business loan underwriting process, cautiously track your expenses and defer any large expense that can considerably change your cash flow.
Preparing for the small business loan underwriting process can seem byzantine, unconditionally. There are so many variables involved and making a decision can be sometimes overwhelming. To make the process easier, get help from networks of experts—and look for someone you can depend upon. Their knowledge not only give you the understanding and accelerate the process but also help you make an intelligent decision! The current lending marketplace is expanding with more and more experts joining the industry, and their skills set can matter in getting you the funds you need with a reasonable small business loan.