When you're applying for a small business loan, it's reasonable to have questions about the process. Making sure you get those questions answered is important in order to understand what you're committing to when you agree to a loan. Here are three of the most common small business loan questions that may come up.
How Much Will I Qualify For?
A lender may offer small business loans of up to $500,000, but that's not a guarantee of how much you'll be able to borrow. Generally speaking, lenders use your debt service coverage ratio (DSCR) to evaluate how much to lend. In simple terms, this indicates whether you have enough cash on hand to meet your debt obligations. Another way of looking at it is in terms of the minimum profitability your business must have to cover the amount of the loan you want to borrow. Lenders tend to look for DSCRs of at least 1.15 (and quite often 1.25).
As an example, let's say your restaurant's total annual net operating income is $200,000, but you'd like to borrow $150,000 to open a second location. This means that your DSCR is 1.33 ($200,000/$150,000), and you should have no issues, at least when it comes to DSCR.
However, if your restaurant already has debt service of $50,000 and is requesting an additional $150,000, the total debt must be factored into the equation. In this case, your debt service would be $200,000 ($150,000 + $50,000), your DSCR would be 1 ($200,000/$200,000) and thus you wouldn't be eligible for the amount you requested. Figuring out your DSCR before applying for a loan can give you an idea of how much capital you'll likely be able to borrow.
How Long Will It Take to Repay the Loan?
Your next major question might be how long you'll have to pay back what you borrow. Answering this question ultimately depends on the type of loan involved.
For example, if you're opting for a short term loan, your repayment period may last three months, six months or a year. If you choose an intermediate loan instead, the loan repayment period may land somewhere in the one to three year range, or go up to five years.
With other types of financing, the loan repayment period may be on the shorter side. If you choose a working capital loan to cover your basic operating expenses for a month or two, for instance, the lender may expect you to pay that back over a span of months rather than years.
It's important to understand how long you have to repay the loan and how that timeline affects your future cash flow. You need to be sure that the money you have coming into your business is sufficient to meet not only your day-to-day expenses but also the cost of repaying the loan over time. Performing a cash flow analysis on a regular basis (preferably at least once a month) can help you develop a better understanding of your cash situation.
Is There a Penalty for Repaying the Loan Early?
When it comes to small business loan questions, one final thing to ponder is whether the lender will tack on a penalty for prepaying your loan. Since the lender often makes money from the interest they charge, if you're able to pay the loan off ahead of schedule, they may recoup some of the lost interest by assessing a prepayment penalty.
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