Obtaining a loan is no easy task. Banks check many aspects of a borrower’s history, such as previous bankruptcy filings, liens, or judgments. Previously, obtaining a $150,000 business loan just required a 700 FICO score and a one page application. The process of lending used to be transacted in the same amount of time required to buy a cheeseburger in a drive-through as well as only relying on borrowers’ personal credit scores. The unsecured nature of loans gave little recourse to lenders apart from the personal commitments and principles of borrowers. The personal guarantees become void when principles are broken. This is the reason why Kenneth Lewis, former chairman BOA, in 2008, commented on the banks’ deteriorating credit quality as “a dam disaster”.
Banks of today are still compensating for the blunders of such loans. This has made the process of obtaining a loan much stricter than before. The underwriting processes that work these days can be summarized as follows:
- An assessment of character through personal credit report.
- Borrowers’ basic character can be questioned with a skipped or missed student loan or child support payment.
- Late payments of mandatory payments like mortgage, car, and credit-card payments are taken into consideration by lenders. Even one late payment is considered an indication of a possible beginning of risk.
- The qualitative sections receive more attention. This includes payment history and public records data.
Importance of Credit Scores
The personal credit score of a borrower is analyzed to find out if the person fits into the general risk profile of the bank. It is assumed that there is a strong correlation between personal credit and the capability of businesses to pay back loans. Scores are also found in the business credit reports, but with the reliability of such as being more questionable than personal credit scores. The reason being that such scores are less reliable as they are made with the cooperation of business partners and often exclude information about prior bankruptcies, payment history and outstanding liens.
Personal credit scores do not affect one’s application but it determines the borrowing costs. Credit agencies like FICO, FICO II, or Beacon have their own methods of calculating credit scores and so it may vary up-to 50 points. Cost of capital increases if the score is below 700.
Income Proof Required
Borrowers wanting to obtain $50,000 in loans, have to verify their income first and provide details of three years of business and personal tax returns. Banks want the guarantee of the borrower’s personal resources in addition to financial pro formas and other personal guarantees. The size of the bank also determines the depth of investigation. A regional bank has a smaller buffer to overcome losses and so they have made deposit certificates compulsory. In case of nationalized banks, the protectionist stand may be far less.
This article was submitted by Rohit Arora, co-founder of Biz2Credit. Biz2Credit is a small business marketplace that connects entrepreneurs with financing options and advice to grow their business. Send all questions to