While making a small business loan application, lenders typically require a lot of necessary paperwork before approving you for a loan. Among that essential paperwork, the information in your annual tax return is consider important to lenders. The lenders have a reasonable justification for requesting this information because the same can helps them protect from encountering bad loans, and that, in turn, helps you with lower rates and fees on the loan. Here are three main reasons why lenders will ask you for a tax return:
- To Validate Your Income
What information lenders review on your tax return is typically based on the type of loan you’re applying for. However, much information can be taken directly from your return or conclude from the mountain of paperwork you provide with your loan application.
A tax return is the most significant document that lenders want to see in order to determine your creditworthiness as a healthy borrower. The main reason why lenders need a tax return is to validate your annual business revenue. They want to see your submitted revenue is steady or rising annually, being it evidence that you can easily repay the business loan. Certainly, lenders want to lend to those borrowers that have the capability to make timely loan repayments.
- To Track Any Losses
Similar to revenues, business losses are also mentioned on your tax return. If there are losses mentioned on your return, they are considered red flags to lenders implying you don’t have enough income to qualify for the loan you’ve applied for. Even if you’re able to get approval on your business loan application, the chances are your loan amount will be less than you need with higher interest rates.
Keep in mind that tax deductions can intensely affect reported income. You can use the help of accountants to prepare your documents in order to get you more savings on taxes, and that usually means reducing your income. When you need a loan, you might have to neglect certain tax deductions to demonstrate enough income for loan qualification.
- To Review Debt-To-Income Ratio
Lenders have different criteria while reviewing your loan application. Short-term lenders use tax returns to validate borrowers’ annual revenue. Whereas long-term lenders use tax returns to validate your cash flow is greater than your monthly payment. They need this to calculate your debt-to-income ratio before approving you for a business loan.
Lenders need a debt-service coverage ratio of 1.5 or greater, while some might work with a lower ratio, but a ratio of less than 1.0 will not get approval. In order to secure the best loan terms, a ratio of 2.0 or higher is considered ideal.
The Bottom Line
When applying for a business loan, staying organized and providing all the necessary paperwork is key to a successful loan application. The quicker you provide all the necessary documents, the sooner you can get pre-approval on your business loan.
A business tax return is a fundamental element in the loan qualification process. If you have any questions regarding your tax return submission, the experts at Merchant Advisors can assist you and find the right loan option based on your unique business needs. Give us a call today or fill out a loan application form to get started today!