Monday, June 14, 2010

Getting a Loan: The Rules Have Changed

“If you don’t like something, change it. If you can’t change it, change your attitude.” ~Maya Angelou

So many of the entrepreneurs we help at the Jim Moran Institute are expressing frustration with financial institutions and their new lending processes. In the past, entrepreneurs could get bank loans without too much hassle. However, because of the recent credit crunch, these financial institutions have adopted much stricter loan requirements.

Financial institutions have a gross margin of less than five percent. That is, the differential between the rates they lend and the rates they pay depositors is very low. Under normal circumstances, financial institutions have to make 20 good loans to make up for one bad loan.

Because of the collapse of the real estate and construction industries, many financial institutions have experienced large losses. As a result, their ability to take on risk has been significantly diminished. In general, bad loans reduce income, which in turn, reduces a bank’s equity. Once the bank’s equity goes down, their ability to lend decreases dramatically.

While financial institutions would like to give more loans, they are simply unable to do so. If banks or credit unions are making commercial loans at all right now, they are requiring so much more in an effort to minimize their risk. For example, they now want great business plans backed up by documented facts, not projections.

Many entrepreneurs are taking these heightened requirements personally. However, things have changed, and entrepreneurs just need to understand the new rules.

First, if you are going in for a loan, you just need to expect it to be a much more exhaustive process than previously. Just about all financial institutions are now requiring some form of collateral to cover the loan. While this might seem onerous, it is just a precaution these financial institutions are taking to ensure they do not lose any more money. The more collateral you offer, the higher your likelihood of getting a loan.

Additionally, financial institutions are carefully evaluating a borrower’s ability to repay the loan. We are working with a business that is looking to secure a loan for the property they are using. In this case, the financial institutions are requiring personal guarantees (which is normal), but they also want documentation showing the business’ past financial performance. They want to ensure the business is going to be able to make rent payments back to the owners, thereby minimizing their probability of loss.

If you are currently in the market for a loan, you just have to realize that the rules have changed drastically. Getting a loan is much tougher, but understanding the new rules and being able to anticipate what financial institutions are now looking for will make the process far less frustrating.

You can do this!

1 comment: