Most small-business owners might need to go into borrowing or applying for a bank loan at one time or another, and applying for one involves much more than filling out paperwork and saying a prayer.

Among other things, you need to consider the state of your personal and business finances, how you’re going to repay the loan, and how much money you actually want to borrow.

While not every borrowing company has their online feature services and you want to get a loan from them, here are the top ten frequently asked questions when getting a loan for your reference. We will also look at other factors to consider when borrowing for your personal use or for your business.

• 10 Most Asked Questions About Borrowing
• What Questions will I be Asked when Applying for a Loan?
• What are the Best Source of Borrowing?
• What Problems are Associated with Borrowing Things?
• How can I Avoid Borrowing Money?

10 Most Asked Questions About Borrowing

Here are some of the key questions you should ask before starting an application:

1. Is it likely I will qualify for the loan?

You’re only going to hurt your credit if you apply for a loan you won’t get. “Just like if you get declined for a personal credit card, it makes it more difficult to borrow in the future,” says David Gass, a business consultant and coach in Meridian, Idaho. “If you get turned down, it looks to the next bank like you’re a bad risk.”

Read Also: Structured Settlement Loan

He suggests asking lending institutions about their specific requirements before applying. Many will let you know the minimum credit score they require, the cash flow you need to show, and other qualifying factors.

2. How much do I really need to borrow?

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. Does your customer pay you in 60 days, but you have to pay your vendors in 15 days? If so, you might need extra money to tide you over.

“It will reflect poorly on you if you come into the bank asking for $50,000, then they ask you to create a cash-flow projection and you find out that you actually need $100,000,” says Adam Hoeksema, co-founder of Muncie, Ind.-based ProjectionHub, a Web app to help entrepreneurs make financial projections. “You should know how much you need and how you will use the funds before approaching the bank.”

3. How much can I borrow based on the asset I’m using for collateral?

Business owners often think if they purchase a piece of equipment for $100,000, they should be able to borrow $100,000 by pledging the equipment as collateral. But banks usually don’t agree, Hoeksema says.

“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 might lend up to 70 percent of the value of a new piece of equipment, and maybe only 60 percent for a used piece of equipment.

4. Do I have adequate cash flow to repay the loan?

Your banker will probably ask you to provide financial projections for the business. Make sure to include your debt repayment plan in those projections.

Bankers are going to be looking for businesses that have some wiggle room, and you may need to show available cash flow that is three times greater than your debt payment requirements, Hoeksema says. “They don’t want to see if you lose one customer, you won’t be able to make your loan payment this month. If your projections show that you have very little room for error, you are likely to scare them away.”

5. Will the money help my business grow?

If you’re borrowing $10,000 for payroll or other routine operating expenses, you’re not generating more revenue from the loan and could find yourself in the same spot three to six months from now. Instead, you should put borrowed dollars into the parts of the business that will generate more revenue over time and help reduce future borrowing needs, Gass says. “If I take that dollar and leverage it, put it into sales and marketing and drive more revenues — $1 driving $5 — then it’s worth it. It’s all about growing the business.”

6. How good is my business credit score?

Most people know their personal credit score, but very few know their business score, says Rohit Arora, CEO and co-founder of Biz2credit, a New York-based company that arranges loans for small businesses. As with personal credit, you can find your business credit score through Experian, Transunion or Equifax. If the score isn’t as high as you think it should be, it might be because there are outstanding liens against your business.

Also, check to make sure your vendors are reporting your payments. You can try to boost your score by reducing the balance on your business credit cards or requesting a credit-line increase to lower the percentage of your available credit in use. “The lender is going to check your business, and your score is the final arbiter of whether you get the loan or not,” Arora says.

“Even if you have stellar personal credit and good assets, if a lot of business contacts are saying you’re paying them late, that’s going to scare off lenders.”

7. Are my personal finances in order?

Bankers may want to look at your “global financial statement,” including personal information like outstanding student loans, personal credit card debt, and mortgage payments. Until your business reaches a substantial size ($5 million to $10 million in annual revenue or more), the bank is going to rely heavily on your personal financial statement and personal credit score to determine the creditworthiness of your business.

“If you have a $200,000 mortgage on a house worth $250,000, and you have $200,000 in student loans, the bank may not see you as a good candidate for a loan,” Hoeksema says. “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.”

8. Do I have all the documentation I need to apply for borrowing?

Arora says some studies have shown that as many as four in five loans never close — “not because the business didn’t qualify, but because of the paper chase.” When applying for a business loan, you will need a lot of documentation.

For example, if you’re seeking a Small Business Administration loan, Arora recommends you provide the last three years of business and personal tax returns, personal financial statements and financial projections for the next 12 to 24 months. “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 might be outdated,” he says. 

9. Does the loan have a prepayment penalty?

When you take out a loan, find out if you’re free to pay it off early without any penalty. Some states allow lenders to charge prepayment penalties, in which case you should try to negotiate a compromise. For example, you could 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,” says Jeanne Brutman, a New York-based financial planner for small-business owners. “By having good excess cash and a paid-off or [paid-down] line of credit, it shows the lender you are responsible with debt and can handle an increase in your total credit.”

10. If I die, how will the loan be repaid?

It’s 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’s not true,” Brutman says. If you leave a large life insurance policy, for example, the bank may come after that.

Find out what a lender’s policy is in the event of your death to best determine how to protect your family. “Most business owners understand that if they’re collateralizing their house and the business fails, they could lose their house,” Brutman says. “But they may not understand that if they die, it doesn’t cancel out their debts.”

It may be best to put your assets in your spouse’s name if the spouse doesn’t have an ownership stake in the business. Brutman also recommends personal property and casualty insurance coverage, which in the event of your death, takes business debt into consideration.

What Questions will I be Asked when Applying for a Loan?

Successfully raising money means knowing what a potential lender will ask you before you commit to a meeting or lengthy application process. You want to get yourself and your business affairs in as much order as possible so that you can tell the lender all the things that he or she needs to hear to make up his or her mind about your potential as a borrower.

Here are six questions a lender will typically ask you.

1. How much money do you need?

While this question may seem obvious, it’s sometimes the obvious questions that prove most difficult to answer. A lender won’t ask you how much money you want—they’ll press you for what you need. Lending money is a cautious, prudent, conservative sort of business.

Lenders want to see that, where finances are concerned, your business is the same. Ideally, you should be able to show a lender that you’ve thought this question through to the last cent, that you’re borrowing only what you need.

2. What does your credit profile look like?

This one’s important because it can make or break whether or not a lender will even ask the next 4 questions. Depending on what lender you choose, they may pull both your personal and business credit reports or scores. If these are both solid, they’ll move onto the questions listed below. If you have derogatory marks on your credit report, they may ask about those as well.

3. How will you use the money?

This question is really about how you’ll use the money to build your business. If you need to buy a truck, for example, it won’t be enough to simply say you’ll use the money to buy a truck. You should be able to explain how a truck is integral to your small business.

Here, lenders are looking for an answer that will assure them that you can pay back the loan. For example, “working capital” or “expansion/growth opportunities” are good answers to this question—they ensure the lender that their investment will increase your revenues. Loan requests for “repaying old debts,” on the other hand, will likely be rejected.

4. How will you repay the loan?

Great question! You’ll repay the loan with the proceeds of your booming small business, of course. But a lender will need more assurance than that. They’ll want to see that you have enough assets, savings and personal collateral to (a) survive the ups and downs of business life and (b) still repay the loan. They may ask if you have current or past loans, any outstanding business debts, and they will likely want to take a look at your previous business or personal tax returns.

5. Does your business have the ability to make the payments required under the loan?

For an existing business, proof of solid cash flow sufficient to the terms of the loan will go a long way towards securing the loan. A lender may ask to see a balance sheet and profit and loss statement from the previous year. A new business owner’s best bet is to show that they’ve been profitable in a comparable business venture in the past, or have a strong expertise and have done their research in the particular industry of the business.

6. Can you put up any collateral?

Collateral is something (such as a house or inventory) you pledge as security for the loan in the event that you cannot repay it. If you don’t repay the loan, your lender takes the collateral. Collateral will be extremely important if you are hoping to secure a bank or SBA loan. Other alternative lenders may not ask for collateral, but they may ask for a personal guarantee on the loan.

With a personal guarantee, you agree to be personally responsible for the debt if worse comes to worst and your business is forced to default. Unlike collateral, a personal guarantee is not tied to a particular asset, however, it does put the business owner in a tough spot to pay back the loan should the business not pan out as expected.

To a small business owner just getting started, some of this may seem unfair. But it might help to put yourself in the lender’s shoes: thousands of people apply for business loans every day, and it’s impossible to predict a winner based on nothing more than a good idea and a business plan.

What are the Best Source of Borrowing?

Nowadays, professional financing options are many and varied. Below, we’ll outline some of the more popular borrowing sources, we will also review some of the pros and cons associated with each.

1. Banks

Banks offer a variety of mortgage products, personal loans, construction loans, and other loan products depending upon their customers’ needs. By definition, they take in money (deposits) and then distribute that money in the form of mortgages and consumer loans at a higher rate. They make their profit by capturing this spread.

Banks are a traditional source of funds for those purchasing a house or car or those that are looking to refinance an existing loan at a more favorable rate.

Many find that doing business with their own bank is easy. After all, they already have a relationship and an account there. In addition, personnel is usually on hand at the local branch to answer questions and help with paperwork. A notary public may also be available to help the customer document certain business or personal transactions. Also, copies of checks the customer has written are made available electronically.

The downside to getting financing from a bank is that bank fees can be hefty. In fact, some banks are notorious for the high cost of their loan application or servicing fees. In addition, banks are usually privately owned or owned by shareholders. As such, they are beholden to those individuals and not necessarily to the individual customer.

Finally, banks may resell your loan to another bank or financing company and this may mean that fees and procedures may change—often with little notice.

2. Credit Unions

A credit union is a cooperative institution controlled by its members—the people that use its services. Credit unions usually tend to include members of a particular group, organization or community to which one must belong in order to borrow.

Credit unions offer many of the same services as banks. But they are typically nonprofit enterprises, which helps enable them to borrow money at more favorable rates or on more generous terms than commercial financial institutions. In addition, certain fees (such as transaction or lending application fees) may be cheaper.

On the downside, some credit unions only offer plain vanilla loans or do not provide the variety of loan products that some of the bigger banks do.

3. Peer-to-Peer Lending (P2P)

Peer-to-peer (P2P) lending—also known as social lending or crowdlending—is a method of financing that enables individuals to borrow and lend money without the use of an official financial institution as an intermediary. While it removes the middleman from the process, it also involves more time, effort, and risk than using a brick-and-mortar lender.

With peer-to-peer lending, borrowers receive financing from individual investors who are willing to lend their own money for an agreed interest rate. The two link up via a peer-to-peer online platform. Borrowers display their profiles on these sites, where investors can assess them to determine whether they would want to risk extending a loan to that person.

A borrower might receive the full amount he’s asking for or only a portion of it. In the case of the latter, the remaining portion of the loan may be funded by one or more investors in the peer lending marketplace. It’s quite typical for a loan to have multiple sources, with monthly repayments being made to each of the individual sources.

For lenders, the loans generate income in the form of interest, which can often exceed the rates that can be earned through other vehicles, such as savings accounts and CDs. In addition, the monthly interest payments a lender receives may even earn a higher return than a stock market investment.

For borrowers, P2P loans represent an alternative source of financing—especially useful if they are unable to get approval from standard financial intermediaries. They often receive a more favorable interest rate or terms on the loan than from conventional sources too.

Still, any consumer considering using a peer-to-peer lending site should check the fees on transactions. Like banks, the sites may charge loan origination fees, late fees, and bounced-payment fees.

4. 401(k) Plans

Along with comparable accounts, such as a 403(b) or 457 plan, 401(k) plans allow employees to invest money on a tax-deferred basis. Their primary purpose is to provide for an individual’s retirement. But they can be a last resort for financing.

The money that you’ve contributed to the plan is technically yours, so there are no underwriting or application fees if you want to withdraw it. Or rather, borrow it—since a permanent withdrawal incurs taxes and a 10% penalty if you’re under 59.5 years old.

Most 401(k)s allow you to borrow up to 50% of the funds vested in the account, to a limit of $50,000, and for up to five years. Because the funds are not withdrawn, only borrowed, the loan is tax-free. You then repay the loan gradually, including both the principal and interest.

The interest rate on 401(k) loans tends to be relatively low, perhaps one or two points above the prime rate, which is less than many consumers would pay for a personal loan. Also, unlike a traditional loan, the interest doesn’t go to the bank or another commercial lender—it goes to you. Since the interest is returned to your account, some argue, the cost of borrowing from your 401(k) fund is essentially a payment back to yourself for the use of the money.

Bear in mind, though, that if you remove money from your retirement plan, you lose out on the funds compounding with tax-free interest. Also, most plans have a provision that prohibits you from making additional contributions to the plan until the loan balance is repaid. All of these things can have an adverse effect on your nest egg’s growth.

5. Credit Cards

If used responsibly, credit cards are a great source of loans but can cause undue hardship to those who are not aware of the costs. They are not considered to be sources of longer-term financing. However, they can be a good source of funds for those who need money quickly and intend to repay the borrowed amount in short order.

If an individual needs to borrow a small amount of money for a short period, a credit card (or a cash advance on a credit card) may not be a bad idea. After all, there are no application fees (assuming you already have a card). For those who pay off their entire balance at the end of every month, credit cards can be a source of loans at a 0% interest rate.

On the flip side, if a balance is carried over, credit cards can carry exorbitant interest rate charges (often in excess of 20% annually). Also, credit card companies will usually only lend or extend a relatively small amount of money or credit to the individual. That can be a disadvantage for those that need longer-term financing or for those that wish to make an exceptionally large purchase (such as a new car).

Finally, borrowing too much money through credit cards could reduce your chances of getting loans or additional credit from other lending institutions.

6. Margin Accounts

Margin accounts allow a brokerage customer to borrow money to invest in securities. The funds or equity in the brokerage account is often used as collateral for this loan.

The interest rates charged by margin accounts are usually better than or consistent with other sources of funding. In addition, if a margin account is already maintained and the customer has an ample amount of equity in the account, a loan is somewhat easy to come by.

Margin accounts are primarily used to make investments and are not a source of funding for longer-term financing. That said, an individual with enough equity can use margin loans to purchase everything from a car to a home. However, should the value of the securities in the account decline, the brokerage firm may require the individual to put up additional collateral on short notice or risk the investments being sold out from under them.

Finally, in a market downturn, those that have extended themselves on margin tend to experience more severe losses because of the interest charges that accrue as well as the possibility that they may have to meet a margin call.

7. Public Agencies

The U.S. government or entities sponsored or chartered by the government can be a terrific source of funds. For example, Fannie Mae is a quasi-public agency that has worked to increase the availability and affordability of homeownership over the years.

The government or the sponsored entity allows borrowers to repay borrowings over an extended period. In addition, interest rates charged are favorable compared to alternative sources of funding.

On the other hand, the paperwork to obtain a loan from a quasi-public agency can be daunting. Also, not everyone qualifies for government loans. There can be restrictive income and asset requirements. For example, with regard to certain Freddie Mac mortgage offerings, an individual’s income must be equal to or less than the area’s median income.

8. Financing Companies

Financing companies routinely make loans to those looking to purchase any number of items. While some lenders make longer-term loans, most finance companies specialize in providing funds for smaller purchases such as a car or major appliance.

Finance companies usually offer competitive rates, and the overall fees can be low when compared to banks and other lending institutions. In addition, the approval process is usually completed fairly quickly.

However, financing companies may not provide the same level of customer service or offer additional services, such as ATMs. They also tend to have a limited array of loans.

Whether you are looking to finance your children’s education, a new home, or an engagement ring, it pays to analyze the pros and cons of each potential source of capital available to you.

What Problems are Associated with Borrowing Things?

Borrowing money can be great when you need an immediate infusion of cash, but it doesn’t come without risks. Check out some of the following dangers associated with borrowing money.

1. High Interest Payments

When you borrow money, you are obviously required to repay the original, or principal, amount back, and in nearly all cases, you pay more than that. There will also be interest, meaning you eventually pay for the lending service.

You may get a low rate (or for some balance transfer credit cards, a 0% interest rate), but interest rates often make borrowing an expensive move. Rates change regularly so you want to borrow when there is a favorable borrowing market. And, of course, it is usually better to use your own savings rather than going into debt.

2. Credit Damage

Each time you decide to go into borrowing money, you risk damaging your credit score if you don’t repay as agreed. But if you make on-time payments, a loan or credit card can be a credit builder. And your credit score impacts many other aspects of your financial life.

It can affect your ability to get future loans, the rates you secure on those loans, whether you can rent your dream apartment and more. It’s a good idea to check your score and work toward improving it. (You can get a free credit report summary, along with two credit scores, updated monthly, from Credit.com.)

3. Strained Relationships

While you’re more likely to get a better deal from a friend or family member, taking a loan from them can lead to a number of awkward situations. It can get difficult for the person to ask for the money back and you may feel a slight sense of guilt or obligation each time you see the “lender.” While this method can help you secure a lower rate, it’s a good idea to have clear rules and a written agreement around any exchange of money. And as much as you can, it can help to stay in touch about other things so your relationship doesn’t get reduced to just a financial transaction.

4. Feeling Stuck

Taking money from a lender requires signing an agreement and making a commitment to pay a certain amount back each month. After that it’s important to make your payments on time. This means even if you borrowed money for something years ago and your needs and desires have changed, you still have to continue payments until the balance is paid in full.

Having these obligations can make you less attractive to new creditors and potential investors in the future, depending on what the loan type is. Be sure you can handle the life of the loan before you sign on the dotted line. Refinancing is an option in some situations, but it won’t eliminate your debt, just restructure it.

5. Less Flexible Budget

Lastly, owing money to a lender will impart cash flow limitations on your future income. Over the designated term of your repayment period, you are assigning a certain amount of your money to repaying your debt. The funds may seem essential at the time you start your loan, but you are effectively eliminating part of your future proceeds or earnings during the repayment period.

You don’t know what you may need this cash for in times to come. If you take a loan, budget the minimum repayment amount into your budget and check regularly in case you can up the payment to end this cash flow limit once and for all.

Whether you turn to a friend, family member, bank or another financial institution, it’s important to be aware of the implications of your borrowing money before you start.

How can I Avoid Borrowing Money?

It can be difficult to stop borrowing money when you are cash-strapped. Here we give you some tips to help you be free of debt.

1. Work out how to live BELOW your means.

This is what you need to do:

• Increase the money coming into your life.

Easier than it sounds you say. But look at what money you have.

1. If you’re employed can you ask for a raise?
2. Or is there any job you can do on the side and/or at home to get some extra cash coming in?
3. What about selling some stuff?
4. Do you have a spare room you can rent out? Take in a lodger or advertise on one of the many websites, like Airbnb, offering affordable rooms for rent.
5. This could bring in a few hundred extra per month and all you need to do is stick the hoover round and smile at a mysterious stranger making a cuppa in the morning.

• Stop the money flying out of your life.

Say to yourself that you will no resort to borrowing any more from today.

Then get to work on your budget or spending plan and see where you can make savings. Decide what spending sacrifices you are willing to make to get out of debt.

2. Keep your Spending in Check

They say that are only three ‘good debts’:

• Your mortgage, which provides a roof over your head
• Your education, which is an investment in your future job prospects and
• Your business, which is an investment taken to fund a viable business.

The rest? Not worth it.

Get tough on how much you spend on credit cards. Look through your statements – did you really need all the things you’ve bought?

Even if you are spending on luxuries like a holiday, it may be worth skipping this year’s holiday or spending on clothes until you get your spending and debts under control. It’s a sacrifice, but to be free of debt your spending needs to be reduced somehow.

Being debt free is one of the greatest experiences or feelings you will ever have. Trust me. It’s totally worth it.

3. Create a Spending Plan

A spending plan is your plan for your money. A budget or a spending plan is an important step to financial security. Knowing your finances inside out – by setting your outgoings against your incomings – will help you live within your means and stop borrowing money.

So, get that spreadsheet out and make a detailed list of all your spending, debt, and earnings. But be honest. Once you have that eye-opening figure of how much money you actually have, you’ll be ready to step away from that new credit card. You will also be able to see where you can make cuts and save.

Remember: only spend on life’s necessities until you are free of debt.

4. Work towards a Clean Slate

Set yourself a goal to be free of debt and the lure of borrowing once and for all. How do you want your finances to look in a year’s time? Or five years’ time? If you know you want to be debt-free then you can start taking steps towards that goal.

Read Also: 10 Tips to Becoming Debt Free

If you are struggling with debt crisis then look into getting help. Organizations such as Step Change can help you find a solution to wiping out your debt once and for all.

5. Get into the Savings Groove

What do you do when you’ve got your eye on something you want, but can’t afford it? Put it on the plastic. Why not trying going trad and save up for it instead? It’ll take longer for you to get your mitts on your heart’s desire but it’ll be so worth it.

Putting it on credit will just make the thing cost more in the long run and nobody needs anything that desperately.

If you’re borrowing to fix a leaky roof, broken down car or any other annoyance that life throws at us, think about creating an emergency fund to cover future mishaps.

Bottom Line

After reviewing these questions to ask before borrowing, you may decide a personal loan is right for you. However, the decision to take out a loan comes with obligations and commitment, so it makes sense to thoroughly research your options.