Getting a Small Business Loan
Steps to Increase Your Chances of Getting the Right Loan
Looking for a small business loan from Indian banks? We look at what you need to know to increase your chances of getting a small loan for your business.
Getting a business loan can seem like a daunting task for a small business owner. There are so many riddles on the way to get the loan that it can be downright stressful especially for new entrepreneurs.
The thought of a rejected application after completing the copious amount of documentation can induce sleepless nights. However, it does not have to be stressful if you plan ahead and prepare yourself for success (i.e. a loan sanction) before applying.
Intrigued? Let us give you some tips to get the desired results.
Section A: The Simple 4 Steps
4 Steps to Increase Your Chances of Getting a Small Business Loan
In theory, you have to become a good applicant in the eyes of the borrower. But that’s a vague concept.
So, we are going to give you 4 steps to become the ideal loan applicant and increase your chances of getting a loan to fund your small business.
Step 1: The Important Credit Score
The first thing any lender usually checks to see if an applicant is a good candidate for a loan is their credit score.This is especially true for new small businesses where the repayment capacity depends more on the financial capabilities of the founder/owner than the revenues of the business.
Your credit score tells a lot about how you handle your finances and how much debt you have accumulated/paid off in the past. It is trusted as a good indicator of whether you will be able to repay the loan if you get it. If your credit score is in the desired range then you can move to the next step.
But if it is low then you need to get started with improving it (Warning: it is better to not think about applying for a loan at this point. The lender is likely to reject your application.)
Pay off any high-interest debt you can, consolidate your debts or talk to the lenders to re-negotiate the payment terms. Most banks are keen to take over existing loans of other banks. If you choose a bank that offers lower interest rates, then it is good that you have a talk with them and see if you can transfer the loan. The same goes for credit cards also.
On the subject of credit cards, they are the most dangerous category of debt due to their easy availability, ease of use and high interest rates. Most card companies will offer you interest rates that are at least 24% a year and usually in the approximate 27% per annum range. That means if you borrow ₹100, you are likely to pay ₹27 in one year if you do not repay the loan. So, paying them off first makes perfect sense.
If you are not sure about what to do then it is time to talk to a financial advisor. In short, do anything you can to reduce your debt burden.
Important Tip: The more loans you apply, the lower your credit score gets. More on this in section B below.
Step 2: Finding the Right Lender – Ease of Getting the Loan vs. Terms
Most people do not know the number of options they have when it comes to lenders – public sector banks, private banks, foreign banks, Regional Rural Banks (RRBs) and Non-Banking Finance Companies (NBFCs).
You can choose the lender based on these factors:
- Relatively low-interest rates and flexible terms as compared to others
- Special offers or schemes applicable to you / your business
Here is something not many people may realise: finding the right lender is always a choice between the ease of access to the loan and the terms of the loan. Let us illustrate with an example.
Suppose you have a relatively lower credit score and have had problems turning a profit in your business. Now, if your future funds inflow looks good due to new clients, then it is a cinch you will get the loan right? Unfortunately wrong.
Banks look at historical numbers and future clients are usually not considered or given little importance, especially if you do not have a relationship with the bank. You are more likely to get a loan with higher interest rates from a private sector bank or an NBFC than from a nationalised bank.
So, if your numbers are weak, it is better to talk to an NBFC or a private sector bank to get a loan (provided of course that you can repay it).Applying to a public sector bank may lead to a rejection and if you are applying in your personal capacity, a dent in your credit score.
It makes better sense to talk to a bank representative before you hand in the application, as the bank checks your credit score after you apply (remember the tip from step 1. Also see section B below).Look for points mentioned above – interest rates/ terms, and special offers and schemes.
Note: This is perhaps the most important step of the entire process. If you get all the answers you need, including all the approval criteria, then you will know beforehand whether you will get the loan or not from that lender. You will also know other important details such as the interest rate, the repayment timeline, moratoriums, if any, list of documents needed and so on.
Important Tip: Applying for loans from banks that reject your application means the next bank/NBFC you apply to will see a lower credit score, which in turn, reduces your chances. So, apply to one bank after careful shortlisting. Also, see section B below.
Step 3: Decide the Loan Amount
Do you think that you can get the exact loan amount you ask for based on your business needs? Unfortunately not.
While lenders have minimum and maximum loan amount limits for each loan they offer, the actual loan amount to be sanctioned is determined by the lender after carefully assessing the borrower’s application. In addition to other factors, the repayment capacity of the borrower plays an important role in determining the loan amount they are eligible for.
If the quoted loan amount in your application is higher than what you are eligible for, your application will be rejected.
As we have suggested, verbally check with the bank or NBFC representative before submitting the application.
Important Tip: It is always better to apply for the minimum amount you need rather than the maximum you can get. For starters, it will have a lower interest burden. Also, banks allow borrowers to top-up their loans if the repayment and other terms are good. So, if you need a larger amount amount later, chances of you getting it are higher.
Step 4: Duly Complete the Documentation
Submitting relevant documents is an important part of the process.
For a new business, business proposal; borrower’s identity and PAN; business ownership proof and other documents may be important to show the viability of the business to get the loan. But for an existing business, audited financial statements; ITRs of the past few years (usually 3 years); PAN of business; GST details; and other documents may be important to get the loan.
Incomplete documentation is one of the most common reasons for loan rejections.Important Tip: If you are a small business owner, keep your documents up to date. Spending 2-3 hours (if needed) to keep the file updated will help you avoid last minute hassles.
Section B: A Few Things that May be Important
The Credit Score
When you are excited about starting a new business or expanding your existing business, you may want to get the funds as soon as possible. This excitement may make you want to apply to multiple lenders to win by the laws of probability.
But this may end up taking you on a downward spiral.
Each loan query or application gets captured in your credit report. When lenders look at your credit report, they will be able to see this data and may decide to reject your loan application which, in turn, makes it to the credit report.
Now, multiple loan queries and a loan rejection may discourage other lenders from approving your loan, which will also make it to the credit report.
There is no way out of it.
So instead of applying to multiple lenders, talk and apply to one and wait patiently until you hear from them. If you get the details before you apply, you are more likely to get the approval.
In case you are wondering why credit scores are so important, then that is because the number gives a common standard that cannot be manipulated and which assesses every individual on the same criteria. No bank can sanction a loan to an individual if the credit score is too low – even if they have an ongoing banking relationship going back years. And in a country where networking and whom-you-know matters even now, that is a gold standard that banks can rely on.
Your Relationship with the Bank
Your relationship with the bank matters if you tick most of the approval criteria.
This is because banking relationships will always have a degree of say in loan approval. You see that in special offers for bank customers every day. There are pre-approved credit cards and loans for most of us in our inboxes on a regular basis.
If you know the officials of the branch, they are more likely to view your application favourably than someone’s they do not know.
Also, a small branch is more likely to consider a application favourably, especially if have been banking with them. This is because each branch is given sales targets and those that meet them get rewarded. Since a smaller branch has less clients due to the smaller geography they service, they are more keen to approve the right applications than reject them for trivial matters. You will see this more with nationalised banks, which are unfortunately well-known for their bureaucratic procedures, especially in their larger branches.
And since nationalised banks offer lower interest rates, this point matters. We discuss this next.
The Interest Rate
You know that lower interest rates are good. But let’s demonstrate further why they are important.
Interest rates may seem all right if you get tax benefits like in home loans or if you can write them off in your business accounts.
But interest rates are payments you are making. You are not getting any real benefit out of them in business loans. You could have used the money for other reasons like business expansion, advertising, marketing or even to pay yourself a bigger salary. But you are not.
Let us look at how much a 0.75% interest rate variance adds up in a 5-year loan.
If the loan amount is ₹5 lakh, and you have 2 loan options – an 8.75% rate and a 9.5% rate, then you will end up paying ₹1,19,117 and ₹1,30,056 respectively, a difference of ₹10,939. And that is a significant amount of money in all business senses.
The only reason why the higher rate may be all right is if you don’t have any chances of getting the lower rate loan.
The Repayment Time
Sooner you can repay a loan, the better. And in most cases, having a shorter loan repayment timeline is more important than a lower interest rate.
In fact, we cannot stress this enough, if you have the option for a longer tenure vs. a shorter one, then despite the smaller EMI of the longer repayment period, you should stick with the shorter loan period. And if you cannot, then the goal should be to repay as soon as possible, provided of course, the prepayment changes, if any, is not more than the interest left.
If we take the above example, the interest burden for the 8.75% loan increases to ₹1,70,425 from ₹1,19,117 if we simply consider a 7-year loan instead of a 5-year loan of ₹5 lakh.
If you compare the numbers, you will notice that a 9.5% loan makes more sense in this case than the 8.75% 7-year loan.
A Final Word
Getting loan approval is just a crucial part of the process. However, it is an important one since everything starts after getting money from the lender. Other stages are equally important such as using the funds wisely, following the repayment schedule religiously, etc.
That is it for now, if you want to know more, you can check out our bank-wise business loan pages where we discuss each business loan offered by major Indian banks in detail.