Why commercial loan applications are rejected
Why lenders say no
- You have bad credit or no credit.
- You want too much.
- You want too little.
- You have no collateral or not enough.
- You don't fit the lenders' niche.
- You have tax issues.
- Your business doesn't measure up.
If you're looking for a commercial loan, be prepared for rejection. Bank lenders became more risk-averse during the recession and, to some extent, have stayed that way. Although a variety of nonbank institutions have been created or expanded to fill the void, they're not a good fit for every borrower, even every qualified borrower. With that in mind, there's seldom a good reason to take financial rejection personally.
Conversely, there's every reason to do your homework and come prepared. A phone call or Internet query will tell you the basics about the size and type of deals that interest individual lenders, as well as the standard information they require of borrowers. There's a good chance you'll be shown the door if you can't provide personal and business credit reports, tax returns, profit and loss statements, and other documents unique to the type of commercial property you're trying to finance.
Even the most educated and thorough borrowers run the risk of being turned down for financing. Here are seven common reasons why a loan application can be rejected.
Bad credit or no credit
Banks will generally look at both your business and personal credit ratings in determining whether to grant a loan and setting interest rates. Recent bankruptcies and missed or late payments — especially to lenders — can easily sink a bank mortgage application. So, making payments on time and staying below your credit limit will give your application a big boost.
The story is a bit different with nonbank lenders. They are more likely to base loan decisions strictly on the value of the property being financed, and to listen to the borrower's story. That means they will take into account extenuating circumstances that may have damaged a credit report, and look at your analysis of why the mortgage loan you are seeking makes good business sense.
You want too much
Lenders have limits on how much they will lend, based on their resources and lending policies, that can result in your loan application being turned down even if you meet their credit standards. Most bank and nonbank lenders list loan-size parameters in their print and online promotional material. Check those sources, so you don't waste your time on an application that is sure-to be rejected based on loan limits.
Limits also can complicate refinancing deals. You could be approved for a new loan with better terms than your current mortgage, but still run into bank limits on the amount of cash they'll part with as part of the refinancing transaction.
You want too little
Lenders have minimum as well as maximum loan amounts. All loans require application reviews, underwriting and servicing, and those costs can make small loans unprofitable.
No collateral, or not enough
Lenders want to know there will be some compensation should you default on the loan. That collateral can include the property being financed, as well as personal assets (homes, cars, securities) and business assets (equipment, other commercial real estate). As with credit standards, collateral and loan-to-value ratio requirements are more stringent at banks than at nonbank lenders. The more accommodating guidelines, of course, usually come with higher interest rates.
You don't fit the lenders' niche
Many lenders, especially nonbank institutions, have some specialty in the types of property they will finance — be it multifamily, agricultural, hospitality, medical, etc. — as well as the types they won't touch (i.e., gas stations, mobile-home parks). Specialized lenders are apt to turn down even the most qualified borrowers whose projects are outside of their niche.
Costly unpaid judgments or unresolved disputes with federal or state tax agencies can scuttle your mortgage application. Also, bank lenders often require applicants to sign Internal Revenue Service (IRS) Form 4506, which gives the lender permission to obtain tax information directly from the IRS. Lenders use tax information as the best evidence of a prospective borrower's income. If qualifying or documenting your income is a problem (because you are an investor who owns multiple properties, for example), it may make sense to turn to a nonbank lender and pay the higher price for a "stated income" loan —in which the borrower self-reports income.
Your business doesn't measure up
Lenders want to see your business plan and, in it, evidence that you'll be able to make your commercial mortgage payments. Lenders typically have minimum standards for debt-service coverage ratios (DSCR) that measure your ability to make mortgage payments after meeting other expenses, and use those standards in their financing decisions.
There are, of course, other reasons that lenders turn down loan applications, but these are the most common.
One takeaway from the loan-application process is that most of the problems you are likely to encounter are fixable. If necessary, you can work to improve your credit rating and business performance, change the amount you are seeking to borrow, or find a lender that is better-suited to your needs. It may not seem like it while you are doing the bidding of prospective lenders, but you are the customer and are likely to benefit from shopping around for the best mortgage deal.