Questions to Ask When Applying for a Loan

Whether you’ve been running a successful business for years or you’re just beginning to turn your money-making idea into a reality, most entrepreneurs will need to take out a loan at some point in their career. If you see a potential way to add value to your business and increase long-term profits, but your plan requires more funds than you currently have on hand, a loan may be the ideal solution. Maybe you need a boost of capital to get your first venture off the ground, have an opportunity to acquire a competitor, or need to fund the purchase of essential equipment to optimize your operations. While a loan can offer a welcome financial helping hand in these situations, borrowing money is a serious decision that requires careful consideration. Here are some important ways to prepare for securing financing for your business, including the key questions to ask when applying for a loan. How to prepare for getting a loan In order to secure a loan, you’ll need to work with a lender, which is typically a financial institution like a bank. Before applying for a loan, it can be helpful to have a solid understanding of how lenders assess potential loan candidates. These criteria are sometimes described as “the 5 C’s of credit” and they can help you discern how likely you are to be approved for a loan: Character: Your credit history and past interactions with lenders Capacity: Your income and other debts you may have Capital: Your net worth Conditions: Overall health of the economy as well as the terms of your loan Collateral: Specific assets that could be redeemed to cover the cost of the loan if you fail to make payments It’s also a good idea to gather the documents your lender will likely require as part of your loan application, such as government-issued identification, pay stubs, previous tax returns, bank statements, and a credit report. You can also prepare for getting a loan by reviewing these essential questions. Questions to ask when applying for a loan Do I need a loan to achieve my business goals? Before applying for a loan, it’s important to critically evaluate whether borrowing money is the best option for achieving your business goals. This step may seem intuitive, but taking the time to identify how and why an influx of capital will benefit your business will guide you in making other major decisions about your loan. Do I have a strong business plan? Once you determine a loan will help you meet your business goals, it’s a good time to take a second look at your business plan. Create an honest snapshot of where your business is at right now, how you hope to grow in the near future, and how you intend to get there. Are you confident your business model is going to generate revenue over the short and long term? Loan money is best put towards activities that will ultimately drive up your revenue. No matter how you intend to spend your loan funds, map out how this influx of capital will lead to increased revenue within the context of your overall business plan. What type of loan is right for me? Many businesses are eligible for government-backed loans as part of the Canada Small Business Financing Program. The program helps small businesses secure loans more easily by sharing the risks with the government. By contrast, loans that are not secured by a government entity are sometimes known as conventional loans. As you may expect, in order to qualify for a conventional business loan, you’ll need to have a specific business purpose for applying for the loan, such as starting a business or expanding. Some entrepreneurs opt for a home equity loan, which is a loan against the equity in your home. Or, if you’re struggling with debt, you might consider a debt consolidation loan––a single larger loan that’s used to pay off smaller, high-interest loans. It’s best to work with your bank to determine the type of loan best suited to budget and business goals. How much should I borrow? While it can be tempting to borrow as much money as you can qualify to receive, it’s wiser to only borrow what you need. The amount of your loan will impact the size of your payments, and therefore borrowing more than you require can create additional costs that may not be offset by the revenue you earn through using the loan. Your loan purpose and business plan can help you determine the ideal amount to meet your goals. If you’re borrowing to purchase supplies or fund a specific project, you should be able to estimate the anticipated costs ahead of time in order to evaluate a sufficient loan amount. Since many banks and lenders specialize in managing loans of various sizes, knowing how much you want to borrow can also help you determine the right lender for your loan. In addition, the amount you hope to borrow can help you work with your lender to decide on the right type of loan for your business. What’s my credit score? Lenders rely on your credit score as an indication of how likely you are to repay your loan and make payments on time. Your credit score, therefore, has a direct impact on your ability to secure a loan as well as on the interest rate you’ll be offered. Lenders typically evaluate your company’s credit history as well as your personal credit record, which includes information like student loans, credit card debt, and mortgages. If you’ve typically made credit card payments on time and maintained a low balance on other credit accounts, it’s likely your credit score will be favourable for a loan. Before beginning the process of applying for a loan, it can be helpful to order a copy of your credit report from Equifax Canada or TransUnion Canada. This will give you an initial sense of how likely you are to be approved for your loan, as well as the kind of interest rate you might expect. Is a personal guarantee required for the loan? Many lenders will require a personal guarantee for a business loan, which means you’ll be personally liable for paying back the loan even if your business dissolves. This may mean the lender will consider personal assets, such as real estate, vehicles or stocks, as collateral for your personal loan guarantee. If you fail to pay back your loan, the lender could seize these personal assets or take action against you personally to recoup the funds. How long will it take to get the money? Particularly if timing is important to your plans for your loan, it’s a good idea to have a timeline in mind for when you hope to receive the funds to ensure you’ll have access to extra capital when you need it. Depending on the loan amount as well as the type of loan, you may receive the money within a few business days, or it could take longer. You can expedite the process by preparing the documents your lender is likely to need and ensuring you have all of the necessary paperwork ready to go before you begin your application. What is the term of the loan? It’s essential to have a clear understanding of the terms of your loan, since this impacts how much interest you’ll pay and the timeline you have to pay off your loan. If you’re able to comfortably afford a larger monthly payment, you may want to choose a shorter loan term in order to decrease the total amount of interest you’ll pay on your loan. On the other hand, you may prefer the more affordable monthly payments that come with a longer repayment period. The ideal loan terms strike a balance between minimizing the interest you’ll pay over time while still offering you manageable monthly payments. It’s also important to think about how long it will take you to repay the loan and how your payments will impact other financial goals you may have for that time frame. What interest rate will I pay? The interest rate you pay on your loan depends on a number of factors, such as your credit score, income, the term of your loan, and the amount you’re borrowing. The higher your interest rate, the more extra money you’ll need to pay in addition to your principal loan amount. You want to know how much of your regular loan payments will go towards repaying the principal and how much will go towards the interest. You also want to understand whether your loan is a variable or a fixed-rate loan. In a fixed-rate loan, the interest rate remains the same throughout your loan term regardless of how the prime interest rate changes over time. Your monthly payments will therefore remain the same throughout your loan term, which can be helpful if you prefer the simplicity of predictable and consistent payments to factor into your business financial plans. A variable loan, on the other hand, is a loan in which the interest rate changes throughout your loan term based on the market conditions. This can allow you to benefit from lowered monthly payments if the prime interest rate drops, but you could also face higher payments if the market conditions do not go in your favour. Can I afford my monthly payments? Take the time to map your regular loan payments in your business’s financial plan to ensure you can manage the monthly payments. You might also want to consider how the loan payments will impact your business's overall profitability. Consider any other debt you’re currently paying off and other regular expenses and payments you’ll need to manage along with your potential loan payments. If you’ve been in business for some time, you should have a good sense of your cash flow and how much you can comfortably afford to pay each month. If you’re a newer business, it can be tempting to plan to pay off the loan with the profits you’re sure to earn. In this case, however, it’s best to heed the adage “prepare for the worst and hope for the best” and consider how much you can really afford if your business doesn’t take off as quickly as you project, or if you encounter unexpected hurdles along the way. If you’re not absolutely certain you can make your monthly payments on time and ultimately pay back your loan, it’s best not to borrow. Do I need to pay any fees? In addition to interest, there may be additional fees associated with your loan. These could be annual or one-time fees, such as charges associated with processing your loan application. You also want to inquire about fees you could potentially be charged, such as late payment fees or prepayment fees if you pay back your loan early. You want to have a good grasp on all of these fees, so you can factor them into the decision of whether the loan will be financially viable for you. How much is the loan going to cost me? Before you apply for a business loan, read the fine print and ask yourself: how much is this loan going to cost me in the long run? The above questions will guide you in determining this answer. Remember that the amount you borrow is not what you’ll ultimately pay. Make sure to factor in your monthly payments, interest rate, and fees. It’s important to crunch the numbers and understand the true cost of your loan. Borrowing money can be an intimidating step in your business development. Preparing by knowing the answers to these critical questions can help you feel empowered as a borrower and allow you to confidently access the money you need to take your business to the next level.