When you’re starting a business and need financing, you can’t just ask a bank for a loan in good faith. Before your business builds its financial history, lenders will look at your credit report to approve or decline your business loan. If you have strong credit, you will have access to larger loan amounts and better terms. If your credit is poor or bad, you may have trouble getting the financing you need.
Here’s what you need to know about how your personal credit shapes your ability to get a business loan and what you can do if your credit needs a boost.
The Fair Credit Reporting Act (FCRA) is on your side
First of all, before you try to get a business loan, start by cleaning up your personal credit. Pull your free credit report from Experian, Equifax and TransUnion to find out where you stand. Most importantly, look for errors, out-of-date accounts, and incorrect negative grades on your report. These mistakes can completely destroy your ability to get funding for your business. The good news is that you are not stuck with these mistakes. You have rights under the FCRA to dispute the inaccuracies and force the credit bureaus to investigate.
If you discover an error, file a formal dispute with the credit bureaus to have it removed. This is the only way to remove late payments, incorrect balances and accounts from your credit report. Once disputed, the FCRA gives the credit bureaus 30 days to investigate. If they cannot verify the information, they must remove it. This can work in your favor as even a 50-100 point increase in your credit score can lead to significantly lower interest rates. The key is to get your score above 620, and if you can get it to 760, you’ll get even lower rates. If you encounter any problems, contact a consumer protection attorney to pursue your right to redress.
Lenders use your personal credit to assess business risk
When your business is brand new, it doesn’t have a financial history for lenders to review. The only way lenders can make financial decisions is by looking at the business owner’s credit report. That’s why startups are evaluated based on the owner’s personal credit history. Obviously, higher credit scores improve the chance of loan approval. Lower scores don’t necessarily prevent a business from being approved, but conditions will be stricter and interest rates will be higher.
Better credit unlocks lower interest rates
Getting approved for a loan is nice, but high interest rates can cost you a ton of money. Your credit profile generally determines your interest rate. The better your profile, the lower your interest rate. Over time, even a small change can add up to thousands of dollars. And for most businesses, higher interest rates make growth more difficult and create cash flow problems.
Sometimes, sellers check personal credit
Having strong personal credit can help you grow your business faster. It’s not just banks that care about your credit. If you are working with a supplier trying to get extended payment terms, they may also check your credit. For example, salespeople are more likely to approve “Net-30” or “Net-60” terms. for business owners with good credit. If your business is new and doesn’t have an established credit profile, sellers will want you to have good personal credit.
Personal credit affects your ability to rent space and equipment
If your business needs to operate out of a physical space or use expensive equipment, your personal loan will be used to negotiate those terms. For example, potential commercial landlords will review your personal credit before approving your lease. Equipment lenders will also assess risk based on your personal credit. If your credit is good, you’ll have lower down payments and better terms. Poor credit is likely to require a higher deposit and stricter lease terms, which can limit access to capital and slow growth.
Small business loans often come with personal liability
Many small business loan lenders require personal guarantees. This means that your personal loan is directly tied to the repayment of your business, even if your business has built up credit. In these situations, if your business fails, your personal credit will take a hit. Having strong personal credit from the start gives you a better chance of securing favorable terms in this situation.
Build your credit first, then build your business
Even when you have the best idea and a clear plan, poor personal credit can make it difficult to start your business. To avoid unnecessary obstacles, fix your personal credit first and then start building your business.
Photo by Sasun Bughdaryan: Unsplash
