What are the 4 factors that banks review when deciding to lend you money for your new apparatus?
Credit approval decisions are based on 4 key criteria. This article will list all 4 criteria and offer some ideas to help you improve your odds for approval and better financing offers.
The 4 key criteria are:
1. Financial information quality. The first criteria a bank will consider is your financial information. The bank will review the information to determine if the information is complete and accurate. Since the bank will never count how much you make from your fundraisers or donations or contracts, it must rely upon your financial information to assess your ability to repay the loan. Your financial information must clearly classify your financial results according to general accounting rules. Is all your revenue reported? Have you listed all your expenses? Does your financial information show all your assets (stuff you own) and liabilities (money you owe others)? Finally, do you have someone that understands and can discuss and answer questions about the financial information? This is the first and they key factor since the bank must have confidence in the information you provide for them to make a professional loan decision. It is recommended that you complete standard forms such as a IRS for 990 (for tax-exempt and volunteer fire departments) or a accountant’s audit (for anyone). These forms are standard and provide confidence to the bank. You score better when your information is accurate and complete.
2. Repayment ability. The bank will use the information you provide to perform an analysis of your ability to afford the payment. The bank will calculate “cash flow” which is the amount of money left over when subtracting your operating expenses from your revenues. The bank will compare your cash flow to the payment amounts (for this new loan and all your other loan payments). The bank will generally require that you have enough cash flow to cover all your loan payments plus a cushion to cover for any unplanned items. The more cushion you have, the better your credit score. Think of the cushion this way: If you had an unexpected major repair, you want to have enough funds in your budget to pay your expenses, complete the repair, and pay all your payments timely. If you don’t have that cushion, you are more liklely to become past due on the loan payments and the bank will score you lower.
3. Cash Balances. The bank will also consider the amount of your savings and/or rainy day funds. They will compare the amount of funds you have in relation to your annual revenue. For example, do you have half a year of revenue in savings? Or more or less? Perhaps you have more than one full year of revenue in hand. The reason that the bank reviews this balance is that your rainy day funds are a measurement of your ability to withstand dramatic shifts in your funding or major capital expenditures. For example, if your revenues decline by 33% (which is happening today given the housing meltdown), a strong savings cushion will help minimize the financial impact of that decline. In other words, you can use your savings to help pay the bills and make the loan payments. The more savings you have in relation to one year’s revenue, the better you will score in a credit analysis.
4. Your equity in the apparatus. The final criteria is how much have you invested into the purchase of the apparatus. In other words, are you making a down payment? The higher the down payment, the better your score. The bank measures your investment into the purchase as your commitment to the purchase. It’s a true lending fact, more defaults and credit problems arise when no money is paid down. When a department makes a down payment, they are less likely to miss payments or be past due. After all, the department will protect the money they invested in the apparatus.
How you can improve your credit score
If you are thinking about borrowing money for an apparatus purchase, focus on improving all 4 criteria to improve your chances of approval and getting better rates and terms.
* Have you financial information reviewed by an accountant for its accuracy and completeness. It may cost you some money but you’ll be paid back quickly with better financing terms.
* Understand how much you get in revenue each year and how much you must spend on operating expenses. Using this information, you can determine your repayment ability and measure if you have enough to afford the apparatus payment (with cushion).
* Be a saver. Keep at least 6 months of revenue on hand. That means if your budget is $100,000 per year, have rainy day savings of at least $50,000. Financially strong departments have at least 12 months of revenue in savings.
* Make a down payment. Show your commitment to the purchase by placing 10 – 20% down on the apparatus purchase. This is a reasonable amount that shows your good faith.
There is a logical method that banks determine if you are likely to repay your loan. By knowing these 4 criteria, you can improve your score and get better rates and terms.