What Do Banks Need for Loan Requests?
When you are interested in getting a loan, there is a lot of information the bank will request to process your loan. Whether you are applying for a business loan or one for personal use, the necessary information can generally be broken down into four categories:
The banker will need to positively identify the borrower and any co-borrowers. For personal loans identification typically takes the form of a driver's license or state-issued identification card, a military identification card, a passport or immigration card (green card).
For business loans, the banker will need a certificate and/or business license showing the business entity is recognized by the government as a legal entity. The banker will also request the entity’s Articles of Organization or Incorporation. This is the information filed with the government to establish the entity.
If the business is owned by more than one individual, the bank will ask for an operating agreement. This agreement formalizes the relationships between the owners, documents each owner’s interests and powers and details how they will interact with each other and with others.
2. Assets and Liabilities
Quantifying the assets and liabilities of an individual or business assists a banker in establishing the financial strength of the borrower. For personal loans, a borrower may complete a consumer loan application that includes a balance sheet or a schedule of the borrower’s assets and liabilities. On business loans, the bank will request the firm’s balance sheet and a personal financial statement which is the balance sheet of the owner.
The application, personal financial statement and balance sheet include information about the level of liquid assets owned by the individual or entity. Liquid assets are cash or other assets that are easily converted to cash like bank accounts, stocks, bonds and life insurance with cash value.
The balance sheet also includes information on other assets including real estate, ownership interests in businesses, vehicles, household goods and anything else of value owned by the borrower. Balance sheets also include information about liabilities or the debt obligations of the borrower.
Debts may include credit card balances, installment loans, real estate loans, leases or any other legal obligation of the borrower. For liabilities, the banker not only needs balances but also the payments associated with those balances. This allows them to determine the debt payments already owed by the borrower or their debt service requirements. Debt service requirements are a key component to the banker’s cash flow analysis and are crucial in the analysis of most loan requests.
Asset and liability information allows the banker to compute the net worth or equity of the individual or business. Net worth or equity is simply the difference between assets and liabilities. An individual with significant assets and limited liabilities has a high net worth. A borrower that owes as much as they own has no net worth and borrowers that owe more than they own have a negative net worth or negative equity in the case of a business. Banks prefer to work with borrowers with positive net worth or equity because: 1) it shows they have leveraged their income and debt to create wealth that can be converted to cash to repay debt, and 2) because these borrowers have assets that can be used to secure or collateralize loans.
Since cash flow is usually what repays loans and since cash flow is derived from income, bankers are anxious to identify the income of the borrower. For individuals and businesses, bankers ask for two to three years of tax returns.
On consumer loans, bankers may request a recent paystub that shows year-to-date income since the last tax return was filed. On
business loans they may ask for an interim statement. These are the most recent monthly or quarterly income statement or profit and loss statement available and show business income since the last tax return was filed.
For most business loans, the banker will request both business and personal income information because the owner typically guarantees the business debt of the borrowing entity. This information allows the banker to conduct a global cash flow analysis. This analysis calculates the combined cash flow of the business and owner and compares it to their combined debt.
In many cases, especially small businesses, the global cash flow is the true determinant of a borrower's ability to repay a loan. This analysis recognizes the owner’s ability to move money between themselves and their business through salary, owner draws or dividends and allows the banker to consider all available cash flow and compare it to all the debt that must be serviced by both the business and owner.
The final information a banker will need for a loan request is information about the collateral. The banker needs to specifically identify the collateral, just like it did the borrower. This information may include a legal property description for real estate or the make, model, year and vehicle identification number for a vehicle.
For some collateral like inventory, accounts receivable or fixtures, the banker will want a list of the assets and the value placed on it by the borrower. Documentation of collateral can be extensive and may include requests for insurance information, ownership information or details of the asset. Regardless, in most cases, the goal is to assist the banker in specifically identifying the collateral and assist them in determining its value.
Preparation Makes the Loan Application Process Easier
Understanding what information a bank needs to process a loan request and in some cases, why they need it, might alleviate some concerns about the loan process. It may also give insight into how banks view borrowers and why.
Be thorough in providing the documentation requested by a lender and you give them the tools they need to assist you and/or your business.
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