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What is the Debt-to-Income Ratio for Small Business Loans?
What is the Debt-to-Income Ratio for Small Business Loans?
Debt to income ratio

What is the Debt-to-Income Ratio for Small Business Loans?

Applying for a small business loan can be overwhelming and confusing. How do you know if you will be accepted? Can you do anything to increase your chances? Making sure you are in good financial standing can increase your chances of qualifying for a loan.

To determine your financial situation, At 504 Capital—an SBA CDC in Virginia, Maryland, and North Carolina—we want to provide you with the tools you need to succeed. So, we have created a guide to help you understand the requirements of an SBA loan and determine your eligibility.

Small Business Loan Requirements

If you are looking for a small business loan, there are a few requirements that you must meet to qualify. These requirements change based on the type of loan you are applying for and the specific SBA lender. In general, the main conditions a lender will review are:

  • Your credit score
  • The amount of time you have been in business
  • Industry
  • Collateral
  • Financials
  • Ability to repay existing and new debt

The most important of these are your financials and your businesses’ total revenue. When reviewing your application, your lender will calculate your debt service coverage ratio (DSCR) and your debt-to-income (DTI) ratio. These calculations help them understand your financial situation and how much annual revenue you can put towards a new loan.

What is a DSCR?

The debt service coverage ratio (DSCR) refers to the business’s ability to repay debts and determines the business’s overall financial situation. This number accurately reflects the overall standing of the business. It helps the lender determine how much of your monthly income you use to pay off debts and if you currently rely on help from outside sources.

What is a DTI ratio?

The debt-to-income ratio measures the consumer’s ability to repay personal obligations, which plays a factor in business lending. As a result, the debt-to-income ratio is one of the aspects that lenders use to determine eligibility for a loan. This criterion allows lenders to determine how much you can afford to pay and how much they can lend to your small business.

Calculating DCSR and DTI

To calculate the DSCR, you divide the annual net operating income by the total debt obligation.

DCSR = Annual Net Operating Income / Total Debt Obligation

For example: If your business makes $100,000 in a year and owes $50,000 a year in debts, your debt service coverage calculation would look like this:

DSCR= 100,000 / 50,000
Debt Service Coverage Ratio = 2

How to Calculate DTI

The debt-to-income ratio is a percentage. This percentage takes the total monthly personal debt and divides it by the total monthly income.

DTI= (Total Monthly Debt / Total Monthly Income) x 100

For example: If you make $3000 per month and you owe $500 a month in outstanding debt, your debt-to-income calculation would look something like this:

DTI= (500/3000) x 100
DTI= (.16667) x 100
Debt-to-income ratio= 16.67%

Requirements for 504 SBA Loans

Your chances of receiving an SBA 504 loan are widely dependent on your DTI and DCSR. Lenders want to ensure that your business is in good standing before providing you with a loan. Consequently, lenders are very particular about the DTI percentage and the DCSR score.

In general, you are more likely to qualify for an SBA loan if your DTI is below 50% and your DSCR is 1.25 or higher. The higher your DTI, the less likely you are to qualify for a loan as a general rule of thumb. Consequently, the same rule applies to a low DSCR.

This requirement is because lenders are looking to make a return on their investment. However, if you cannot pay back the loans, it goes into default, and they lose their money. However, if you meet the requirements, you are considered a lower risk for defaulting on the loan. This consideration is due to your ability to pay back the loan.

Case Study

Let us consider, for example, a small business in good standing:

  • Their annual net operating income is $36,000 a year ($3000/month) and their total debt obligation for the year is $6000 a year ($500/month).
  • This gives them a DSCR of 6.
  • This leaves them with $30,000 a year in total profit, giving them a considerable amount of room to take out a new loan.

Now, let us consider an example of a small business that is struggling:

  • Their annual net operating income is $36,000 a year ($3000/month), but their total debt obligation for the year is $35,000 a year ($2916.67/month).
  • This gives them a DSCR of 1.02.
  • This leaves them with $1000 a year in total profit and very little room for additional debt.

SBA Lender in North Carolina

Are you looking for an SBA lender in Maryland, North Carolina, or Virginia? Look no further. 504 Capital is here to help. We are an SBA CDC lender that specializes in 504 loans. Our team of professionals will review your application with a careful and thoughtful eye. Our lending officers are dedicated to helping your business succeed. As a result, we use our skills and knowledge to provide you with the expertise you need to succeed.

Ready to apply? Contact us today and see how we can help.

Apply Now