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Nine questions to ask before taking a loan

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A loan is an arrangement in which a lender gives money or property to a borrower, and the borrower agrees to return the property or repay the money, usually along with interest, at some future point(s) in time. Usually, there is a predetermined time for repaying a loan, and generally the lender has to bear the risk that the borrower may not repay a loan (though modern capital markets have developed many ways of managing this risk).

There are some striking  questions that must be asked before securing a loan.

  • Is it likely I will qualify for the loan? It is advisable to ask lending institutions about their specific requirements before applying. This will help you to know if your loan application can be honoured or turned down.
  • How much do I really need? Before you approach the bank, make sure you have a good handle on how much cash you actually need. The best way to determine this is to create a monthly cash-flow projection. You should know how much you need and how you will use the fund before approaching the bank.
  • How much can I borrow based on the asset I am using for collateral? Banks will value your asset below what you think the value should be, and then they will only lend up to a certain percentage of the value of the asset. For example, banks may lend up to 70 per cent of the value of a new piece of equipment, and maybe only 60 per cent for a used piece of equipment.
  • Do I have adequate cash flow to repay the loan? Your banker will probably ask you to provide financial projections. Make sure to include your debt repayment plan in those projections. If your projections show that you have very little room for error, you are likely to scare them away.
  • Will the money help my business grow? If you are borrowing for payroll or other routine operating expenses, you are not generating more revenue from the loan and can find yourself in the same spot three to six months from now. Instead, you should put borrowed money into the parts of the business that will generate more revenue over time and help reduce future borrowing needs.
  • Are my personal finances in order? Bankers may want to look at your global financial statement, including personal information like outstanding loans. If you have a lot of personal debt and very little collateral that you can provide to the bank, you may need to find a strong co-signer.
  • Do I have all the documents I need to apply for the loan? When applying for a business loan, you will need a lot of documents. If you go to the lender and are not fully prepared, not only does it make you look unprofessional, but by the time you get the documentation in place, it may be outdated.
  • Does the loan have a prepayment penalty? When you take out a loan, find out if you are free to pay it off early without any penalty. For example, you can agree to a penalty only if you pay off the loan in a relatively short period of time, say, within six months from the time of the loan. Prepayment is especially valuable if you believe your business may grow soon and you may need a larger line of credit.
  • If I die, how will the loan be repaid? It is something most people don’t like to think about, but in the event of your death, an unpaid business loan can affect your family. Most people think, if I die, the bank is out of luck, but that is not true. If you leave a large life insurance policy, for example, the bank may come after that.