What Is Business Loan Underwriting?

Rebecca LakeUpdated April 22, 2023

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Editor’s note: Lantern by SoFi seeks to provide content that is objective, independent and accurate. Writers are separate from our business operation and do not receive direct compensation from advertisers or partners. Read more about our Editorial Guidelines and How We Make Money.

If you need funding for your company, a small business loan is one possibility to consider. Business loan underwriting represents the bridge between your applying for a loan and your receiving the loan proceeds. When a business owner applies for a loan, approval isn't automatic. Potential lenders review both the business's and the applicant’s financial details before making a decision on funding. This process is small business underwriting. Understanding how the process works can be helpful when you’re applying for financing. Here's a closer look at what happens when a loan is submitted for underwriting.

What Is Business Loan Underwriting and Why Is It Necessary?

Generally speaking, underwriting is a review process in which information is verified and risk is measured. If you apply for life insurance, for example, an underwriter reviews your health details to assign you to a risk class. Underwriting small business loans involves the potential lender looking at financial health, rather than physical health. This step is necessary to help the lender decide whether to loan a business money or not, and if it does decide to proffer the loan, what amount and what repayment terms will be offered. Just like life insurance underwriting, small business underwriting is a way to gauge risk. If a lender looks at a business owner's financials and deems the prospective borrower at higher risk, it may charge a higher interest rate on a loan. If it considers the risk too great, it may deny a loan to the applicant altogether.

What Does a Loan Underwriter Do?

When you apply for a small business loan, your loan is assigned to an underwriter. This is someone who's been specifically trained in how to underwrite a business loan. Broadly speaking, it's the underwriter's job to determine whether you're qualified to receive a loan, based on the information you provided in your application and the lender’s requirements. On a more granular level, underwriters dig into specific details of your personal and business finances. Here's a closer look at what business loan underwriters may consider.

1. Collateral

Secured business loans require some type of collateral. For example, if you're applying for an equipment loan, the equipment you're purchasing might serve as collateral. In other cases, your company vehicle, for example, or your storefront, if you own it, might serve as collateral.Loan underwriters will look at the value and quality of the collateral offered for a loan to make sure it meets the potential lender’s small business loan underwriting guidelines. Effectively, the underwriter is making sure that if you default on the loan, the lender has a reasonable chance of getting back some of what's owed by repossessing and/or selling the collateral.

2. Credit

Credit is central to qualifying for a small business loan. The minimum credit score required for a loan can depend on the type of loan and the lender. A potential lender may look at both personal and business credit scores or may focus only on business credit. In either case, the underwriter reviews your credit to make sure it aligns with what the lender is looking for.

3. Business Income

Before a lender approves a business loan, it typically wants to know that the borrower has the capacity to pay it back. So another key factor in small business loan underwriting guidelines is income. If you’re applying for a loan for an established building, an underwriter may look exclusively at business income. If you're trying to get a startup loan for a business that isn't generating revenue yet, then your personal income can generally be substituted.

4. Equity

Equity represents the value of the small business after liabilities are deducted from assets. This value is important as it's used to calculate certain financial ratios for your business that can be used to measure its overall health. Loan underwriters can look at your balance sheet to weigh debts against assets.

5. Other Considerations

Understanding how to underwrite a business loan can mean looking at other factors beyond assets, debts, or revenue. When underwriting business loans, lenders may also consider things such as:

How much the owner has personally invested in the business (i.e. how much skin he or she has in the game)
The business owner's experience and track record in business
Whether a personal guarantee has been offered
Other sources of income that could be used to repay a loan

The goal of business loan underwriting is to create as complete a picture as possible of a business owner's finances. The underwriter uses all the information you provide to the lender to do that.

How Business Loan Underwriting Works

There are three basic steps involved in underwriting small business loans. The process includes:

Application
Review
Decision

Step one is your submission of your application to the lender. How you do this can depend on the lender and type of loan. The way SBA loans work, for example, is very different from the way business loans from an online lender work when it comes to applying. But generally, you'll need to fill out the application and provide any supporting documentation the lender requires. The next step is the review. This is where the main activity related to business loan underwriting takes place. An underwriter combs through your application to ensure that it meets the small business loan underwriting guidelines prescribed by the lender or loan program. At this stage, the lender may follow up with you to request additional information or clarification and to obtain your consent for a credit check if one hasn't been completed already. Assuming you meet all the lender's requirements, the business loan underwriting process wraps up with loan approval. At this stage, the lender will tell you how much you've been approved for and at what repayment terms. If you're happy with the terms, you'd just need to sign off on the loan documents. From there, you can receive the loan proceeds through direct deposit into a bank account or check. If you are denied, it may be a good idea to discuss why so that you can prepare better if you decide to try again with another lender.In terms of timing, underwriting small business loans can happen relatively quickly or more slowly, depending on the specifics. Online lenders, for instance, may be able to underwrite and approve loans in a matter of days while an SBA loan could take several weeks to finalize. That's something important to keep in mind when weighing loan options if time is of the essence for getting financing.

Helping Your Application Through the Underwriting Process

Navigating the business loan underwriting process may seem overwhelming but it doesn't have to be if you understand how it works. Here are some tips for applying for a small business loan successfully.

1. Know What You Need to Apply

Submitting an incomplete application for a business loan can lead to snags in underwriting to your application being denied outright. So before you begin, be sure you understand what the lender needs to start the underwriting process. That can include:

Basic personal information, such as your name, address, and Social Security number
Your business name or doing business as (DBA) name
Your Employer Identification Number (EIN) if you have one
A copy of your business plan
Information about collateral if you're applying for a secured loan
Details about your business, including time in business, annual revenues, number of employees, et cetera
Financial records, including tax returns, bank statements, and/or pay stubs

Getting this information together beforehand can save you time when filling out the loan application. Reviewing your credit scores, banking activity, and cash flow can also help you pinpoint any potential issues that might come up during underwriting. For example, if you have a late payment on your credit report, the lender might ask you to explain the reason behind it in detail.

2. Choose the Right Loan Amount

Consider how much money you need to borrow and how much a lender is likely to approve you for, based on your credit and financial details. If you haven't worked out a detailed budget for what you need to borrow, it's a good idea to do that before submitting a loan application. Apply for too little funding and you may need a second loan to fill the gap. Apply for too large a loan and you may end up having to repay more than you needed to begin with. And if the loan amount doesn't match up with your ability to repay as determined by the underwriter, you could be denied altogether.

3. Fill Out the Application Thoroughly and Accurately

Omitting information from your loan application or providing incorrect information could hold up the underwriting process, especially if you have to resubmit a new application. So before submitting your application to the lender, review it to make sure you haven't missed anything. This is a relatively simple step, but it can make loan underwriting easier later on in the process.

The Takeaway

Small business loans can help you take the next step in your business's growth, whether that means opening a new location or upgrading your business equipment. Finding the right loan to fit your needs and budget matters, and it's important to do your research before applying. If you don’t, your application may get held up or even denied during the underwriting process. If you're interested in exploring small business loans, visit Lantern today to find the right financing for your business.

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About the Author

Rebecca Lake

Rebecca Lake is a freelance writer specializing in personal finance, investing and small business. Her work has appeared online at U.S. News and World Report, Forbes Advisor, CreditCards.com and Investopedia. Rebecca writes about a variety of topics for SoFi, including budgeting, saving money and student loans.

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