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HOW DO COMMERCIAL LENDERS VIEW BORROWER’S CREDIT
HOW DO COMMERCIAL LENDERS VIEW BORROWER’S CREDIT?
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A typical commercial lender differs from a residential mortgage lender. This is because they appraise a borrower’s credit differently. The main reason is that commercial loans usually have money. This is to include some more complicated structures. The focus is on the business or investment property’s profitability and risk rather than just the owner’s financial profile. Commercial lenders view credit during underwriting as follows:
Importance of Personal Credit Score:
- The personal credit score of an applicator is only sometimes the greatest.
- Nevertheless, it is still important since the loan is especially important in small business loans.
- The business owner borrows, and the business and the individual are closely intertwined.
- A favorable personal credit report (680+) increases the chances of an application being more likely to be approved yards forward individual credit score.
Assessment:
- Lenders have always used borrowers’ credit scores to decide their inclination toward settling debts.
- Examples are late payments, high credit utilization, collection, and new bankruptcy closings.
Business Credit Score: Key Focus for Commercial Loans: For a business with an established and thick reference credit line with suppliers and optimal purchase volumes at a producer’s (or wholesaler’s) market).
It’s about business identity: The business credit score (from Dun & Bradstreet and other agencies) is more critical than personal. This score indicates the probability of the borrower’s business repaying debts.
Components:
- The creditor’s business score is evaluated based on the company’s repayment performance with suppliers.
- The type of credit availed and the company’s trade credit age.
- A high business credit score is indicative that the business pays its bills promptly and has efficient credit management.
Debt Service Coverage Ratio (DSCR)
Definition:
- DSCR is the most important parameter integrated by commercial lenders to assess a business or investment property’s ability to sustain and repay its debt.
- Debt Service Coverage Ratio is done by calculating the net operating income (NOI) ratio over the total debt obligations (debt repayment as to principal and interest) for a given period.
Preferred Ratios:
- Most lenders prefer a minimum DSCR of 1.2 and above 20%.
- This means the business or property generates surplus income.
- Cash 20% more than required to settle the debt.
- A lower DSCR may automatically compel lenders to offer higher interest rates on the loan.
- Otherwise, the loan could be denied.
Significance:
- This ratio shows how well-placed a financial institution or a property is.
- This is especially true if revenues go down.
- However, loan obligations up to that time must be maintained.
Borrower’s Financial History And Stability
Financial Statements: Lenders analyze financial statements such as balance sheets, income statements, and cash flow statements to evaluate the borrower’s and the business’s financial status.
Cash Reserves: A steady cash reserve is a desirable trait in a borrower as it shows that even in trying times, the borrower can remain active and still make their loan repayments.
Profitability: A business that has consistently made profits over time is a positive factor for lenders since it demonstrates that it can earn enough income to cover its debts.
Collateral: Collateral Value:
- A commercial lender typically needs collateral from the borrowing party.
- This can be real estate, machinery, stocks, or other company assets.
- The amount of collateral significantly impacts the lender’s decision-making process.
Loan-to-Value (LTV) Ratio:
- The loan-to-value ratio compares the mortgage loan to the property’s value.
- When it comes to commercial loans, an investor would aim for a loan-to-value ratio of 65% % to 80% LTV.
- This gives the maximum loan amount of 65% to 80% of the property’s value.
Business and Industry Risk: Industry Type:
- This relates to the risk prevalent in the borrower’s industry.
- Some industries are riskier than others, e.g., restaurants and retail.
- Lenders will demand a higher credit score, more collateral, or even a higher DSCR to minimize this risk.
Economic Conditions: Finally, the lender’s risk assessment also considers the general economic situation and the market situation of the business or type of property that the borrower operates in.
Borrower Experience and Track Record: Business Experience:
- It is generally understood that lenders prefer borrowers with substantial industry experience.
- Or those who are just dealing with the respective property types.
- That particular experience reduces the lender’s risk exposure.
- The more experienced borrowers can run the business efficiently and manage any challenge that may come along.
Track Record:
- A successful history of handling similar projects.
- Businesses can be used to offset poor credit scores or financial statements.
- This is because it indicates the borrower’s ability to perform.
Personal Guarantees: Requirement:
- Most business lending institutions request their borrowers present personal guarantees concerning the amount borrowed.
- Especially where the business is young or the provided financials could be stronger.
- In this case, if the debt is not serviced, the borrower himself has to pay off the provided loan.
Impact on Approval:
- Personal guarantees often help increase the chances of getting loans.
- This is because the borrowers offer personal warranties.
- Even with other weaknesses, such as insufficient business or collateral.
Loan Structure and Terms: Interest Rates:
- In terms of loan interest rates, it is also noteworthy that the borrower’s credit profile.
- This, including personal and business credit scores, directly affects the offered interest rate.
- Better credit scores are usually associated with lower net effective rates.
Loan Amount and Term:
- The risks associated with the individual borrower will influence the loan limits and terms.
- Larger loans or longer terms could restrict certain credit profiles or encourage more stringent credit limits.
- Commercial lenders have a different approach to a borrower’s credit.
- Business and personal credit scores are evaluated along with business health, assets, industry, self, and more.
- However, a good credit history may help one’s access to financing.
- This is because lenders mainly focus on the business side of the individual.
To gain commercial financing, you must have strong personal and business credit, sufficient income, and good collateral.