Business Debt Consolidation Loan: 7 Underwriting Questions Lenders Ask

You ask “how much can I get”. The bank is going to ask “how much room do you have”. What that means is how much is your cash flow divided by all yearly principal and interest, the new loan included. Banks often want to see about 1.25X coverage. A coverage of 1.25X says your cash flow covers one time principal and interest plus an extra 25%. The right loan is a math problem and too much existing debt is a common reason for denial.

First question by the lender is what is your real cash flow. And, no, tax return net income isn’t the answer. Take net income and add depreciation, amortization, interest and one-time items back. Subtract the required spending to keep plant equipment up.

Some add-backs get questioned: operating the business out of the owner’s own building where above-market rent is paid by the business to the owner; keeping a family member on the payroll. Each one might make sense to an owner, yet the loan officer might not agree.

Second bank question is, “What are all your other obligations”. Take a full year’s worth of principal and interest on every obligation the business has - not just the loan you want but every financing. There are term loans, notes for equipment, real estate mortgage and leases. If the line of credit has a balance not paid down, count it like term debt.

Third question is, does the coverage ratio meet the lender’s target. It’s common for lenders to ask for a ratio of 1.20-1.25 times yearly debt service. With long-lived collateral, long history, diverse customer base, stable industry, the lender may need less cushion. But if there’s cyclical revenue, a short track record, one big customer, you may need a bigger margin for safety.

Say you start with cash flow of $600,000. Suppose the debt, new and existing, is $490,000 for the year. 600 / 490 = 1.22. The company hasn’t done anything wrong. The coverage isn’t low, but not high enough for this lender’s box. If your coverage is 1.0X, then all the cash flow is spoken for. And one bad quarter of cash flow means a missed payment. 1.25 means the company can survive a twenty-percent drop and still pay its lenders. This “cushion” is distance from trouble.

Restructure Your Existing Debt

To raise coverage, you could try growing sales, although that takes time. The quickest way to get financing is usually to restructure your existing debt. Stretch the existing payments of $310,000 to $240,000 and match the term to the land and building. Combined with the new loan payment of $180,000, total annual payments are now $420,000. The $600,000 cash flow, divided by $420,000 of payments, equals a coverage ratio of 1.43. The business hasn’t changed.

A payment you can afford is not a loan amount. It turns into a loan amount depending on rate and term. If what is bought isn’t long lived, don’t match a longer amortization.

SBA 7(a) Loans

The fourth question: what kind of debt are you consolidating? SBA 7(a) loans can be used to refinance business debt, most up to $5 million. But it depends on the type of debt: merchant cash advances and factoring agreements cannot be refinanced with a 7(a) loan (SOP 50 10 8).

The fifth question is whether you could get this loan anywhere else. To be SBA-eligible, the borrower must not be able to get credit on reasonable terms from non-government sources. Lenders must document this. For most SBA loans, there is a minimum coverage ratio lenders must use, which varies based on the loan size. Most lenders underwrite a higher coverage than this SBA floor.

The sixth question is about you, personally. Many lenders run global coverage, looking at your household, the drawings from the business, and your own mortgage. If too much money is being distributed from the business, global coverage can be a reason for denial even though business coverage is fine.

The word “guarantor” means exactly what it says: by signing, you guarantee you will pay it. Under SBA rules, anyone owning 20% or more of the business usually is required to guarantee the loan. And although the borrower is the business, your credit as owner is factored into the SBA’s decision on eligibility.

Prove the Numbers

Seventh: Can you prove the numbers? Bring in a one-page, neat schedule of every debt with rate, payment, maturity, collateral. Bring support for every add-back. The lender will look for interim statements that reconcile to your last tax return. Lenders can pull IRS transcripts with the signed 4506-C if they want to.

When you get your loan there may be a cash flow coverage test which they’ll measure in the following quarters or years. There will likely be a definition of what is “cash flow” and “debt service” - the numerator and denominator. Make sure you’re comfortable with the wording of that definition. If you fall out of compliance, it’s a technical default, regardless of your perfect payment record. And is there a cure period?

If your loan package is close, the odds are you can structure your way out of the problem. Confirm what the lender underwrites to. It is a fair question. If term can be lengthened, or if there is an add-back, or if a note that is scheduled to be paid down can be stretched out, there is math to do.