Business lenders will use the debt-to-income calculation of the business owners to in many cases determine if the business is pre-qualified for a loan. This a very true for small businesses with under one million in gross revenue and almost always true of businesses operating as sole proprietors.
What is debt-to-income?
Debt-To-Income or DTI is the measure of personal income to personal (reported) debt. DTI is a major factor in determining your risk of default, If your DTI is too high then you are overburdened with monthly debt and much more likely to default if anything at all goes wrong.
Why is debt-to-income useful?
For the small business owner, lenders will look closely at the personal DTI. While the loan is a business loan a personal guarantee will be required on the loan and if the owner's DTI is already too high then the risk of a full default becomes much more likely in the event the business should fail.
This means that as a business owner you should always consider if you have the personal ability to service the loan if the business goes under. If the answer is no then you may want to seek other types of financing that are not personally guaranteed.
How do you calculate debt-to-income?
To calculate your debt-to-income, you will divide your total monthly debt payments by your gross monthly income. This will include everything you have a monthly debt obligation payment for such as your; mortgage, auto, student loans, credit cards, installment loans, etc. For credit cards estimate 3% of your outstanding balance. A DTI example would be that you have a total monthly payment obligation of $2,000 a month and your monthly gross income is $6,000. Therefore your DTI is 33%.
What is a good debt-to-income?
Now that you know how to calculate your DTI, what is considered a good DTI and how does that apply to business lending? A DTI of 33% or less is viewed by almost all lenders, personal and business, as good. From 37% to 43% there is a chance you can still get approved by many business lenders and even more so if your business is showing good net income. Have a DTI of 44% or more and you will find yourself declined for most major loans being they business, personal, credit cards, mortgages, and more.
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