Cofounder, president, and CEO of CapFront, an innovative small business finance marketplace.
When a business applies for a loan, the lender conducts a thorough analysis of the company’s finances and considers the reasons for the requested funding. This process is known as commercial underwriting. Having a clear understanding of how underwriting works can help ensure a smooth and efficient lending process for both parties involved.
Common Commercial Underwriting Factors
During commercial underwriting, lenders need to take many factors into consideration. Although these factors can vary from creditor to creditor and also depend on the loan type, some of the more common ones considered are:
Credit History: A business’s credit history plays an important part in their ability to qualify for funding. Underwriters will look for answers to the following questions when reviewing a commercial loan application:
• Does the company have a positive financial track record?
• How is their past payment history?
• Does the company pay their bills on time or, even better, do they pay early?
• Do they have a large amount of outstanding debt?
Credit Scores Of Owners And Business: During underwriting, a lender may check a company’s business credit score (which is connected to the company’s EIN number) and the personal credit scores of the owners (tied to their social security numbers). Strong credit scores help a business secure the most favorable loan terms.
Time In Business: Many lending agencies require a minimum age of a company in order to qualify for funding. This ensures that a business is well-established, profitable and comfortably able to make periodic repayments.
Monthly Or Annual Revenue: Applicants will usually need to provide both business and personal financial statements in order to obtain financing. Underwriters will use bank statements to check a company’s cash flow and get an idea of the average monthly balance, withdrawals and deposits to ensure a business will be able to repay any potential funds borrowed.
Collateral: While many business loans are unsecured and uncollateralized, some types of funding products can require collateral. One example of this is equipment financing, which is self-secured (meaning that the equipment itself acts as collateral for the loan).
There’s More To Commercial Underwriting Than Meets The Eye
Successful commercial underwriting is not quite as straightforward as one may think. There are many other variables to take into consideration. One of the most overlooked areas of commercial underwriting is understanding the effects of macroeconomic events on human behavior. In fact, this is the key to effective underwriting. There are a few examples of how recent microeconomic conditions have impacted the way consumers are making purchasing decisions, thereby allowing certain business sectors to capture additional customer spending.
Since the start of the Covid-19 pandemic, supply chain issues have delayed the instant gratification felt by Amazon Prime same-day or 1-day delivery. As a result, people have been willing to spend more on services, even during an economic downturn. Because of this, many companies in the lending space are taking a more aggressive approach to providing funding to service industries.
Another example of the trickle-down effect of large-scale events on small business is the Inflation Reduction Act. The bill offers significant tax incentives for clean energy companies. Accordingly, funding companies should consider adjusting their underwriting approach on solar, electric vehicles and similar businesses.
As a result of the pandemic and in an effort to curb their gas usage due to surging prices, many consumers continue to spend more time at home. That’s why the trend of investing in upgrades such as new furniture and home renovations has been steadily rising. As such, lenders may want to modify the manner in which they underwrite loans to construction companies and retail businesses that offer furniture or home décor.
Understanding the effects of macroeconomic events is key to effective commercial underwriting. It’s important to remember that every loan applicant is unique, and a one-size-fits-all approach is not ideal in commercial underwriting. Staying up to date on current events, trends and macroeconomic events will help lenders achieve the most effective underwriting practices.
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