How a Bank Determines a Loan

Ready to buy your dental practice? There’s a good chance you may need a loan for that. So, how does a bank determine whether or not to loan a buyer the money for their dental practice? Dental B-School takes a closer look at what influences the decision.

All right. You’ve found dental specific lender and you’ve successfully submitted your documents. What now? Well, now the lender’s underwriters will review your documents and ultimately, make the determination of whether to lend to you and if so, how much they will lend you.

Many lenders use a specific formula to make the determination.  This formula consists of two parts.

Formula for Lending Determination

The first thing the underwriters will look at is the practice’s income tax returns.  They will take a close look at practice profits and losses and will identify the true net profit of the dental practice.

If the seller is incorporated as an S Corporation or a C Corporation, then the underwriter adds back the following items to the true net profit:

• Owner’s salary

• Spouse’s salary (if the spouse does not work in the dental office – for instance, if the spouse is on the payroll solely for the purpose of making a retirement plan contribution.)

• Depreciation and amortization

• Interest expense

• Owner’s health, life and disability insurance payments

• Owner’s automobile expenses

• Practice retirement plan contribution (some banks may keep the contribution on behalf of the employees, however.)

The first piece of the puzzle is having the underwriter determine the true net profit of the practice.

The next part of the formula consists of the underwriter computing the buyer’s annual expenses, which includes the following:

• Practice loan payment on the practice the buyer wishes to purchase

• Mortgage or rent payment on buyer’s home

• Student loan payments

• Auto loan payments

• Auto expenses

• Personal income taxes

• Buyer’s personal living expenses

The sum of all of those items is the second piece of the puzzle.

At this stage, the underwriter can make the determination by dividing piece one (true net profit) by piece two (buyer’s annual expenses).  If piece one (true net profit) is at least 1.2 times the amount calculated under piece two, then the bank will make the loan.  It’s important to note that some banks use 1.25 times rather than 1.2 times to decide whether to make the loan.

7 Tips to Help You Get Approved for Your Loan

1. Get pre-qualified – Find a dental specific lender and get pre-qualified with them. They’ll review your information, such as you annual expenses that we talked about above, and let you know how much you may qualify for under current market conditions.

2. Keep saving! – Banks like to lend to buyers who have demonstrated that they can save money. So, if you’ve got a nice nest egg in savings and you go to a bank and you are looking at is close to or just less than the 1.2 times ratio we just talked about, then the liquidity may make the difference between them opting to loan you the money. 

3. Do your homework – Many banks will do a telephonic interview with you before making a loan. If you go into the interview prepared and can communicate to them exactly where the revenue-growth opportunities are, you’ll fare much better.

4. Consider an income-based repayment program to repay your student loans – If you are able to cut your monthly loan payments by using an income-based repayment program, this could very well be the difference in making the 1.2 or 1.25 times ratio to qualify for the loan.

5. Keep your credit in check – Make sure that your credit is stellar and at least over 700 so that the bank will not have an issue with you as a borrower.  Work on paying down any credit card or consumer debt, including car payments, before you plan on applying.

6. Maintain lower personal expenses – For instance, having a roommate to lower your rent payment by $1,000 each month could make a difference in the equation. Financial preparedness is key!

7. Be truthful with your lender – The bank wants to make you the loan. Talk to your bank representative if you’re not sure what to put down on your application or if you’re not sure how to fill it out.  

When it comes to securing a loan to open your dream practice, the better prepared you are, the more likely you will be to secure your loan.