Experts noted that loan approval rates skyrocketed in 2019. That’s should be a good thing, right? Maybe. Does anyone remember the housing bubble in 2008, fueled by sub-prime loans? The fundamental fact remains just because you can secure a loan, doesn’t mean that you should. See how this can impact you.
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Traditional Banks Have Been Notoriously Stingy
Historically, expert big banks approval criteria have been notoriously tough for loans. It was almost impossible to get approved without a stellar personal credit rating and some form of collateral and business history. So this reduction of standards is a good thing …if not taken too far.
The approval percentage for small business loan applications at big banks ($10 billion+ in assets) inched up one-tenth of a percent to reach 28% for the first time in the post-recession era during October 2019, according to the latest Biz2Credit Small Business Lending Index™experts.
With the recent interest rate cuts by the Federal Reserve and stronger economic indicators, this doesn’t show any signs of slowing. This is great news for businesses, who are on solid footing. You’ll hear this several times. It’s the mantra of this post: Cheap money isn’t free money, and just because you can qualify for a loan, doesn’t mean you should take it. Sure lending is booming, but that doesn’t make it safe.
Experts Say that SBA Loan Approval Continues to Climb
The government reported for the Fiscal Year 2019 (ending in September), SBA spent $28 billion on over 63,000 loans. Approval rates are above 50% for loans, experts have found. These rates have been inching up at roughly 0.1% per month.
The SBA has strong standards but remember that the SBA reduces the risk of the bank, not you.
“The government guarantees that SBA loans provide to lenders helps mitigate their risk and makes it more palatable for them to grant requests from businesses that might not otherwise qualify for financing.”
While this is overall a relatively good thing, I’ll repeat our mantra: Cheap money isn’t free money, and just because you can qualify for a loan, doesn’t mean you should take it.
Alternative & Institutional Lending is Almost Alarmingly High
Institutional lenders are approving nearly 2/3 of loan applications. Alternative lenders are in the mid 50% levels. These lenders are great if you have a less than perfect credit scores or have less than 2 years in business. In our expert opinion, we think that getting loan approvals through alternate lenders is the safer choice in the long run.
The catch is their willingness to lend more money at higher interest rates. This is where the housing bubble analogy comes to mind. We got in trouble then, when alternative lenders were approved home mortgages to people who would not otherwise qualify. Granted, some did just find. However, once the inevitable default rates started to climb, crisis ensued.
What Does This Mean to You?
Take a few of the fitness tests. If math isn’t your thing, I promise these aren’t too bad. First, take a look at your debt-to-cash ratio. It is a measure of how debt burdened you already are. You can calculate this ratio by dividing your total profits by your total debts.
If the number you get is less that 1.5, you probably should stop here. If you are above 1.5, you already are a bit challenged. Since you will be seen as risky, the interest rate will likely be high. This can make a challenging problem much worse.
The second is to understand how large of a loan to seek. The classic test is below. Note some recommend 1.2 in the denominator versus 1.25.
Just because a lender is willing to give you more, doesn’t mean you should take it. Too large of a loan can stress your cash flow. This can put you at risk if you have surprise cash crunch.
On the whole, if your business is in good shape, you are more likely to get approved with attractive rates. That’s fantastic and should be celebrated. If you fail or are on the bubble with one of the fitness tests above, you should really pause. It would be good idea to revisit the size or the purpose of the loan. If you are looking for a loan approval, think about what experts would advise. Ask yourself, with this loan is it feasible for my business to grow faster than the interest rate? What risks exist that might change that outlook? This doesn’t mean that you shouldn’t move forward. It does mean that you should do so with your eyes wide open to the potential risks and have plans to address them if they happen.