22 Apr 7 Questions to Ask Yourself Before Applying for a Business Loan
When your business is growing, facing a temporary cash crunch, or pursuing a new opportunity, a loan can provide the financial boost you need. But before you submit that application, it’s important to slow down and ask yourself some essential questions. Taking the time to understand your financial situation, loan options, and the long-term implications of debt can mean the difference between using capital strategically and ending up with a burdensome repayment schedule.
This guide walks you through the most important questions you need to ask yourself before applying for a business loan, so you can move forward with clarity and confidence.
1. Why Do You Need the Loan?
Start by pinpointing exactly why you need the funding. You may think the answer is obvious, but defining your purpose will help you determine the loan type, loan amount, and ideal repayment structure. Are you looking to cover short-term working capital needs, such as payroll or inventory restocking? Or are you planning to invest in long-term growth through equipment purchases or business expansion?
Let’s say you’re opening a second location. A term loan with fixed monthly payments might make more sense than a line of credit because you’ll need a large sum upfront. On the other hand, if you’re bridging gaps in cash flow between receivables and payables, a revolving line of credit could provide the flexibility to draw funds as needed. The clearer you are on your loan’s purpose, the easier it will be to align your financing choice with your goals.
2. How Much Capital Do You Really Need?
Overestimating or underestimating your capital needs can cause serious financial issues. Borrowing too little might leave you strapped for cash, while borrowing too much could mean unnecessary interest costs and a higher monthly payment than your business can comfortably afford.
Take the time to do a detailed cost analysis of the project or expenses you’re financing. For example, if you need to buy equipment, get price quotes, factor in taxes, installation, and delivery costs, and account for any downtime during the transition. If you’re using the loan to smooth out cash flow, look at your historical financials to determine the average shortfall and the timing of your receivables. Knowing your exact number not only helps you choose the right loan amount, but it also shows lenders you’ve done your homework, a big plus in the underwriting process.
3. What Type of Loan Is Best for Your Situation?
Business loans aren’t one-size-fits-all. Depending on your needs, credit history, and time horizon, certain loan products will be a better fit than others. Term loans, lines of credit, equipment financing, invoice factoring, and SBA loans all serve different purposes and come with different terms.
If you’re a seasonal business, for instance, a revolving line of credit can help you cover costs during slow periods and repay the balance once sales ramp up. On the other hand, if you’re purchasing a company vehicle or new machinery, equipment financing may offer better terms because the equipment itself serves as collateral.
This is where partnering with a lending advisor can be especially helpful. We work with you to evaluate your options and match you with a loan that meets your specific needs without compromising your long-term cash flow.
4. What Is Your Current Financial Position?
Before you borrow money, you need a crystal-clear picture of your current financial health. That includes reviewing your credit score, business revenue, net income, existing debts, and cash reserves. Lenders will certainly do this on their end, so the more prepared you are going in, the better your odds of approval and favorable terms.
You’ll also want to calculate your debt service coverage ratio (DSCR), which compares your cash flow to your proposed loan payments. A DSCR above 1.25 is typically preferred by lenders, as it indicates you have sufficient income to comfortably cover the loan. If your DSCR is lower than that, you may want to consider borrowing a smaller amount or improving your cash flow before applying.
5. Can Your Business Afford the Monthly Payments?
Even if you’re approved for a loan, that doesn’t automatically mean you can—or should—take it. It’s your responsibility to determine whether your business can handle the monthly payments alongside your existing obligations. Missing payments can hurt your credit and potentially damage your relationship with the lender, making future borrowing more difficult.
To protect yourself, map out how the monthly payments will affect your budget. Will you need to reduce other operating expenses? How will this impact your profitability? What happens if revenue dips temporarily? Do you have a contingency plan?
Imagine your business generates $25,000 per month in gross revenue, and your operating costs, including rent, payroll, and supplies, add up to $20,000. A loan with a $2,000 monthly payment might seem manageable. But if sales decline due to seasonality or market shifts, that cushion can evaporate quickly. Always stress-test your budget under less-than-ideal conditions before taking on new debt.
6. How Soon Do You Need the Funds?
The timeline for receiving funding varies widely depending on the type of loan and the lender you choose. If you’re in urgent need—say, you need to replace a broken-down delivery truck tomorrow—you’ll need a fast funding solution, such as a short-term loan or business line of credit with quick approval times.
Conversely, if you’re planning for a long-term project or expansion that won’t start for several months, you might consider an SBA loan. SBA loans typically offer lower interest rates and longer repayment terms, but they also involve more paperwork and longer underwriting times. Knowing your funding timeline helps you set realistic expectations and avoid last-minute stress.
7. What Collateral, If Any, Are You Willing to Offer?
Some business loans are unsecured, meaning they don’t require collateral. Others are secured, meaning you’ll need to pledge business assets such as real estate, vehicles, or inventory, as a condition of the loan. In many cases, offering collateral can help you secure better terms, but it also adds risk. If you default on the loan, the lender can seize the asset.
You’ll want to weigh that risk carefully. Ask yourself what you’re comfortable putting on the line and how the loss of that asset would affect your operations. For example, if your production line relies on a specific machine, using it as collateral might be too risky if cash flow is uncertain.
Bonus Question: What Is the Total Cost of the Loan?
Many business owners focus solely on the interest rate, but that’s only one piece of the puzzle. You should also consider the total cost of the loan, which includes fees, prepayment penalties, and the impact of the repayment term. A loan with a lower interest rate but high upfront fees could cost more than one with a slightly higher rate and no fees.
Ask the business lending broker for the Annual Percentage Rate (APR), which reflects the total yearly cost of borrowing. Then, use that figure to compare offers side-by-side. Don’t forget to factor in the opportunity cost as well—how will repaying this loan affect your ability to invest in other areas of your business?
Applying for a business loan isn’t something you should rush. By asking the right questions, you can make an informed decision that strengthens your business rather than straining it.
If you are looking for nonbank lending experts in Chicago, consider a consultation with Superior Business Lending. We can help you navigate each step of the lending process.
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Infographic
Before applying for a business loan, it’s crucial to assess the financial and strategic impact of borrowing. This infographic highlights the key questions to consider, empowering you to make informed decisions with confidence. 