Latest / Let's Talk Small Biz Finance with CIC Tucson / Will I Get Funded? Demystifying the Loan Underwriting Process | Coffee Chats with Caroline Nelson
Transcript
- Caroline Nelson: you ever wondered what happens when your loan is in underwriting or what someone means when they say, me talk to the underwriter? Well, today we are going to break that down you. My name is Caroline Nelson. the Chief Operating Officer and Head of Lending and I am joined by my colleague Brandy. Brandi Szymanski: Hi, I'm Brandy Simeonski. I'm the Rural Leading Manager with Community Investment Corporation. Caroline Nelson: We're really excited to be here with you today. Brandi Szymanski: So Caroline, I got a question for you. Why did the underwriter bring a flashlight to work? Caroline Nelson: That's a great, why Brandy, I don't know. Brandi Szymanski: Because they were tired of everybody saying that lending is a black box and they wanted to shed some light on it. Caroline Nelson: You That's great. Yeah. That's exactly what we're doing today. ⁓ All right. So let's start What is underwriting? If you've not heard this term before or you've heard this term and maybe you don't know what it means, ⁓ we want to break it for you. So essentially, ⁓ underwriting is assessing the risk a transaction ⁓ through ⁓ an analysis. And depth the analysis depends on the type of transaction and really how much money you are ⁓ looking for. In the case of loan underwriting, we are looking at your, the financial information of the business to determine if they have enough extra cash flow to make the loan payments. So that essentially is the goal of underwriting. There are other transactions that are also underwritten in our lives. So it's not just loans when you apply for insurance. right car insurance. The insurance company is assessing your risks. They're looking at your driving record. They're looking at your insurance claims. They're potentially pulling your credit. I'm not sure exactly what they look at, but they are trying to decide the likelihood of you placing a claim. And that will determine if you receive insurance and also what your rates are. Brandy, can you think of anywhere else that would use underwriting? Brandi Szymanski: Landlords, when you're putting in a rental application, they're assessing the risk of you being a good tenant and paying your rent on time. So they're looking at your rental history, your credit history, ⁓ references of old landlords to see if you were consistent to assess your risk. Caroline Nelson: That's another really good one, yeah. So these are just a couple examples of places that this might come into play in just our regular daily lives. So underwriting, the goal of underwriting is to determine if a transaction is going to be approved, but it also typically determines in the case of a loan, what your interest rate will be. So when you look up interest rates, you might see that, you know, start at X percent. and they can go up from there or you may see like a range and that just means that the underwriting and your risk level essentially will determine where you fit in that range. Now when we say riskier, what we really mean is the likelihood that a loan will not be repaid. That's what we're trying to assess when we are underwriting a loan. We're looking at the financial history, we're checking to make sure there's cash flow there and we're also looking at payment history. to make sure that that person has a positive payment record. And so all those factors go into whether or not a transaction is approved or you are approved for a house that you're wanting to rent or you're approved for insurance, just a number of examples. So let's dive into what actually happens in the underwriting process. Brandy, you do this all day every day as part of your job. So when you're underwriting a file, what are you looking at? What are you doing? Brandi Szymanski: We're looking at your financials and the documentation that we've had you provide to really determine if you can afford to take on a loan payment. We're connecting the dots. We're going to ask questions. There's going to be a lot of different things that we put into it to determine if a loan makes sense for you right now. Caroline Nelson: Are there, what specific documents are lenders looking at and how do they make their decisions or decide how much of a loan they are going to approve? Brandi Szymanski: We're going to be collecting taxes, we're going to be collecting your business financials, and by that I mean your profit and loss statements and your balance sheets to determine what your business income is, what your expenses are, and at the end of the day whether you're profitable after all of your debts are paid for and your expenses and can actually cover that loan payment. Caroline Nelson: Yeah, one of the challenges we see in this space that we work in in lending and in small business lending is a lot of businesses are not tracking their financials. And so it's really hard for us to make a decision when we don't have information to go off of. So if you have a business, I would highly encourage you to start tracking your financials if you're not doing it now. Because if there does come a time when you do want to apply for a loan or some kind of transaction that does have to be underwritten, you have to have actual data for that company. to use to look at to determine if they are going to be able to approve whatever request it is that you place. So when we're looking at these documents, ⁓ we're checking to make sure there's enough income. We're looking at a bunch of different things. But what actually is going on is we are analyzing the data and we are preparing ratios. And these ratios, there are different limits. that tell us whether or not a loan can be funded or not. So we're not just looking at documents and being like, hey, this looks great. I want to approve this loan. We're actually crunching numbers and making sure that the limits are within the appropriate levels. So one really common in the business world is the Debt Service Coverage Ratio or DSCR. And so this ratio looks at your net income. So your overall income minus your expenses is your net income. So when someone says to you, your business profitable? They're referring to your net income. Do you have a positive income or are you losing money? Right? Is it negative? So we're looking at your net income and we're dividing it by your total debt service. So to get your debt service, we are adding up all of the payments, all of the loan payments you have every month. And that provides us with a ratio. Kind of standard in the industry is 1.25 or higher So what this means is for every dollar in debt that you have you have at least one dollar and 25 cents of income to cover those debts if the ratio is between 1 and 1.25 There's still a little bit of extra money, but not as much right there's not as much of a cushion. We don't want to constrict your cash flow so much that you can't operate or that you can't handle an emergency if it comes into, know, if something comes up. That's why it said at 1.25. If the ratio is, you know, below one, that means you don't have enough cash flow to cover your debts, which is a problem. And that is why a lot of businesses aren't approved for the loan amount that they request, because there's just not enough cash flow there to handle the existing items plus whatever they're requesting. The complexity of your transaction, the amount money you're requesting, the type of business that you have ⁓ all determines what information a lender is looking at and how detailed their analysis is. Just to share some other common things that a lender may be looking at. ⁓ One is a current ratio. So we're looking at your current assets ⁓ and your current liabilities. And so when we say current what we mean when we talk about assets these are things that are your cash or things that can quickly be converted to cash. An inventory that you can sell, payments that are due to you right with things ideally that can become cash within the next year. When we refer to current liabilities we are referring to loans or payments that are due within the next year. So when a lender's looking at your financials specifically your balance sheet in this case They're calculating what you have to pay in the next year and they're looking at your cash to see if you have enough to handle this. So that can be problematic if a business just doesn't have enough cash to make these payments. Where is this money going to come from? Right? Are you taking out loans to pay your bills? Are you going to have an increase in sales? You know, right? We need to be able to connect the dots. And so that may be a question that you get from a lender. Some other things potentially that they could be looking at are your receipt or your inventory. If you have a lot of inventory, how quickly are you selling your inventory? Also your payables and your receivables. So payables, money that you owe others, you may be asked for an aging, payables aging or receivables aging. And this lists how long these items have been outstanded. So receivables, money ⁓ other people owe you. So if you've extended things on credit, let's say. like how are people paying you, right? Within 30 days, 30 to 60 days, 60 to 90 days, 120 days, right? Like of the overall money that is owed to you, how far ⁓ out are people to pay you? Because ⁓ if that's really if we're saying, you know, four plus months, all this is outstanding, the likelihood of you collecting that potentially is slim. And so that ⁓ can't... be used to, we're not certain that those funds are going to come in and so we might not be able to include that in our calculations. Are there other things that you can think of that ⁓ we're looking at? It would be important to mention. Brandi Szymanski: We're looking at credit history as well. ⁓ That tells us a lot about your character, how you've dealt with debt in the past, what kind of balances you're carrying ⁓ with credit cards, ⁓ vehicle payments, mortgages, anything like that to figure out what your total monthly payment in debts is every month, and you're current on those payments. ⁓ Caroline Nelson: Yeah, that's a really important one. So if a business isn't ⁓ making enough money to cover their payments, ⁓ are there other things that we can look at? Are we able to include personal income in a situation? Is that an option? Brandi Szymanski: Absolutely. We can do what's called global underwriting where we're not just looking at the health of the business and the business income and expenses in net, but also just the household in general. So if you have a spouse that's working, what is their income? If you have another primary job, what's that income? But when we are taking that income into account, we're also taking personal debts into account. So that's also going to be personal mortgage, personal vehicle payments, any personal credit cards, student loans, things like that that are also going to affect that ⁓ debt to income ratio. Caroline Nelson: Hmm, absolutely. Now is a global underwriting a requirement in any situations or is it like the applicant's choice if we look at the whole picture? Brandi Szymanski: In traditional banking, it's not always a requirement, but it is generally what we conduct here at CIC. Caroline Nelson: Yeah. And some of the reasoning behind that is we work with a lot of small businesses, solo entrepreneurs, and their income comes from the business. And so if there aren't other sources to support these payments, we want to make sure that the business is able to make their payments and also their personal payments because it's all coming from the same income source. Is underwriting just about the numbers or? Can someone share their story? Does that matter? Brandi Szymanski: ⁓ 100%. ⁓ You can and you should share your story. ⁓ Yes, we're using these numbers to try to figure out what that story is, but context matters. So we're probably going to look at these numbers, do our analysis, and then come back and ask you follow-up questions and figure out why things are the way they are and get you to fill us in on all those details. Caroline Nelson: Yeah, it's important that the story and the numbers match, right? But that context is really important. What are some red flags or concerning trends that you are keeping an eye out for? Brandi Szymanski: When we're looking at your numbers, your financials, we're looking for inconsistent income, ⁓ revenue dips ⁓ year over year, ⁓ net income decreases, and also seeing your debt increasing. ⁓ Debt increasing is definitely one of those things that we want to see going the opposite direction. ⁓ And again, it's also with the credit report, that's one other thing we look at. If you have multiple credit inquiries within a small period of time, that can also be concerning. Caroline Nelson: Yeah, a lot of recent credit or just a lot of credit in general, right, can signal financial distress. And so that is one of the things that a lender's look when they, if they pull credit, or when they pull credit, right, if there's a lot of inquiries, they're gonna want to know why. ⁓ And, you know, ⁓ if you're in bind and you need funds, like that certainly is a reason, but it can also, ⁓ be a potential reason why you're not approved. What are some reasons loans are declined? Brandi Szymanski: ⁓ Generally, it's going to be because the business can't afford to take on the payment. It could also be a current bankruptcy, ⁓ back taxes are another thing that can cause a loan to be declined. Caroline Nelson: Hmm, taxes, that's a good one. Well, not a good one, pay your taxes, but that's a really good one to point out. That is something we see fairly often is back taxes. Not all the time, but often enough that we mentioned it. So if someone is declined, can they apply again or what is, what are their next steps? Brandi Szymanski: 100 % like that they're going to actually be in a better position to apply the next time because they're going to know what steps they need to make to get approved when they come back. Whether that's I need to pay down certain debts so my debt to income ratios look better. I need to work on increasing my sales so my revenue growths are showing on the underwriting. ⁓ I need to pay off my back taxes possibly. Whatever that might be but it's going to help them figure out what their path forward is. Caroline Nelson: Okay. Yeah, something else that can be helpful is changing the loan amount. So we apply for a loan because typically we apply for a loan because we have an idea, we want to complete a project, we want to do something very specific. It can be helpful to have an idea in mind. So maybe you're not able to be approved for the full amount of your request, but you have enough cash flow to cover a portion of that. So you could change your loan amount and reduce it and provide funds to complete a part of your project and then you can kind of level up from there. So also just know that the answer isn't always no, right? There are some different options that we can work through to figure out how to help you continue to move forward and achieve your goals. But it doesn't always look like what we hope when we set out. I do think lenders typically want to see you succeed and they want to figure out a way to ⁓ approve your transaction. And so some of it is just kind of this creative juggling. Okay, well, we can't do this full project, but like what of this can we start with? Like what's gonna help you continue to grow? So it is often just a conversation. How long does underwriting typically take? Brandi Szymanski: ⁓ I mean, it can take a week to a month. ⁓ There's a lot of things that change that figure. ⁓ Having your documents in place, ⁓ being able to be consistent with the lender you're working with whenever they're reaching out and asking questions, it's gonna help things move along a lot faster. And it also depends on the complexity of the loan ⁓ and of the business. Caroline Nelson: Good point. So make sure if you're applying for a loan that you have time in your schedule to work through the process. In our personal lives, loans are a little bit easier, right? Like if you apply for a car loan, you provide your W-2s or your taxes, they pull your credit and they make a decision. Like that's really pretty painless overall. A mortgage is a little more complicated. But in the business world, it's different. ⁓ The lender is looking at a lot more documentation. than in our personal world and ⁓ it just takes a lot longer. We don't have information as easily accessible as we do in our personal lives for our businesses. And so it is going to take longer. The lender's likely going to have questions. They may need to work through a situation with you as we just talked about. So make sure that you have time in your schedule to answer those questions, to provide other documents to work through this because your responsiveness does also influence how quickly they can approve a transaction or make a decision on a transaction. the ways that someone could speed up the underwriting process? Like anything a business could do to make it go faster? Brandi Szymanski: Having your financials already in place, maintaining those on a regular basis, you're gonna be able to pull them and provide them to the lender right away. That's gonna speed things up a lot. Caroline Nelson: So if you are not currently tracking your finances, start tracking your finances. Once you start tracking your finances, we can do a lot with them, right? We can start to prepare documents, we can look at things a different way, but if you don't have that information to start with, that's either gonna be a non-starter or it's gonna take you a lot longer to even apply for a loan because you have to put together all this documentation. This keep track of your finances is basically the theme of everything I do. You'll hear in like every conversation, I'm like, track your finances. But it's really important, right? We're in business for a reason and we have to have money in order to keep our business going. So it's also important that we're keeping tabs on that. Is there anything someone can do to improve their chances of being approved before they apply? Brandi Szymanski: ⁓ Like I said, maintaining those finances, ⁓ having a plan in place. Before you apply, ⁓ you really need to think about exactly how much you need and exactly what it's for. ⁓ You need to be able to answer those questions. You need to think about what collateral you have to secure a loan. ⁓ And that can kind of be a guide for how large of a loan you request. If you have no collateral or if it's a low value, maybe you need to start with a lower loan request. So asking yourself those three questions before you even go and apply is going to really help guide the loan that you're requesting. Caroline Nelson: points. As we talked about in the beginning debt, the debt service coverage ratio is an important ratio in underwriting. And so we're looking at net income. So to start, we want to make sure that your business is profitable, that you have enough extra cash flow to take on this loan. So if you're not sure if you're profitable or not right now, this is a good place to start looking at, right, tracking our finances, looking at ⁓ how much we have left at the end of the day, right? What type of payment can you afford to take on? There's lots of tools on the internet that can help you with this. A lender's even happy, right? We're even happy to help you with this. We can walk you through just some basic calculations. But that can be helpful ⁓ as a starting point before you apply for a loan so that you are applying for a realistic amount given whatever your financial situation is. So for example, I'm gonna use, like if I apply for, if I wanna buy a car and I'm gonna apply for a loan to buy this car, what I do first is I look at my income, you know, subtract my expenses and I know how much I have left. So I already know what type of car payment I can afford. And then I will do like a basic calculation on the internet what a payment would be, right? If I'm buying a $25,000 car over five years. what would that payment be? And I'm comparing that to how much income I have left to know if I can even afford this. ⁓ And if I can't, then I'm adjusting from there. So before I personally apply for a loan, I am doing some of these basic calculations. I do realize that like I do this for a living, so I am an advantage, but any of us can do these basic calculations. There's lots of tools that can help us. And by knowing your numbers before you even apply for a loan, right? If you know you have the cashflow to support this loan, if you know you have the documents in place, your likelihood of being approved is going to be much greater, right? We may need to work through some details, but overall, out of the gate, you already have a lot of positives on your side. So we can work with that, right? If you've got the income, we can work with that. And where we run into trouble is when a business doesn't have the income. One thing we didn't talk about, Brandy, is projections. Can a business, can we use projections in calculations or do many lenders ⁓ allow projections? Brandi Szymanski: So here at CAC, if we're working with a newer business, we are going to ask for projections. ⁓ We're definitely going be doing global underwriting on that. So we're going to be looking at your business projections, what you're expecting your income to be and your expenses to be ⁓ over the next two, possibly to three year period. ⁓ And then obviously your personal income. This is going to be considered a riskier deal. When we are using projections, the risk definitely increases. So if that is how you're moving forward, ⁓ expect to have higher interest rate on some. Caroline Nelson: And not all lenders will consider projections. Newer businesses, you have to look at projections because you don't have enough track record to go off of. You have some history and then you've got projections to build off of. ⁓ But you are going to need to have personal income as well to support this transaction while the business is getting off the ground. So just something to keep in mind. I think that's everything on my list. What are we missing? Brandi Szymanski: ⁓ I think we covered everything. I was going to say we do have a loan calculator available on our website, CICTucson.org. So you can go in there and play with the numbers. What loan amount you're looking for, term lengths, interest rate, to get an idea of what your monthly payment would look like and see if it's something that you can cash flow. Caroline Nelson: That's a great call out. Thank you. If you're not currently keeping track of your finances, we on our YouTube channel, we do have a video called dollars and cents where we teach you how to start tracking your finances if you've not done this before. It's a class on how to build financial systems. So you download the transactions from your bank, categorize them, just start at a really basic level. So this is a great starting point if this isn't something you're doing. ⁓ Overall, I just encourage you, I know this process can seem a little bit scary, like a black box, right? Like it sounds a little scary when someone's like, the underwriter is looking at your file right now. But. We are people, right? We're the ones looking at your file. We're just looking at your numbers and we're trying to make sure that we're not putting you in a worse place. We want to make sure that you can succeed and that we are not constricting your cash flow so that you can continue to operate your business and live your personal life. So that ultimately is what we're doing. ⁓ You know, it can seem a little daunting when someone's asking you questions and it can seem like they're diving into all the decisions that you've made. ⁓ but it really is just a conversation. So please try to approach it from that level. We're just trying to understand and figure out how we can make something work. But we are happy to be a resource. So if you have further questions, you are welcome to reach out to anyone on our team at any time, even if you don't need a loan, if you just want to talk through the process, dive into anything that we discussed today in more detail, please do not hesitate to reach out. Brandy, did you have something you wanted to leave us with today? Brandi Szymanski: Hey Caroline, why do underwriters make terrible gamblers? Caroline Nelson: Why Brandy? Brandi Szymanski: Because they refuse to unless the odds, the backup plan, and the check out. ⁓ Caroline Nelson: These are great. I kind of track that. That's too funny. All right. Well, thank you so much for joining us today. We hope that ⁓ underwriting is a little less of a black box for you and that you as a business owner feel more confident going through the lending process now and understanding what we do when we're looking over your documents. Brandy, thanks for joining me. Brandi Szymanski: Thanks for having me.