Got Bad Credit? Don't Apply for a Loan Before You Ask a Few Hard Questions.
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If you have bad credit, your financing options may be limited and expensive. If you hope to start or a grow a business, you'll need to learn how to judge the status of your credit score and why it matters to your lender. Even more important, you must explore realistic avenues to fix the problems with your credit history.
How do I know if I have bad credit?
If you haven’t already obtained your free annual credit report, do it now via AnnualCreditReport.com. Once you find your score, compare it to the ranges on this general scale:
Excellent: 781 to 850.
Good: 661 to 780.
Fair: 601 to 660.
Poor: 501 to 600.
Challenged: Below 500.
Credit scores can go as low as 300, but anything below 630 will spell trouble if you’re looking for a small-business loan. FICO (the company whose algorithm determines your score) doesn’t share everything that determines a credit score. But factors likely include your current debt, your payment history and how long you’ve held any credit accounts. Each of the three primary credit bureaus -- TransUnion, Equifax and Experian -- reports its own credit scores for individuals, and you can’t predict which score your potential lender will find.
“But what about my business credit?” you might ask. If you’re seeking an alternative lender, your business credit most likely won't play a role in your application. Many banks will take your business credit score into account, but if your small business still is in its early years, your chances of securing a loan from a traditional lending institution are notoriously slim. Banks commonly reject even healthy small businesses and will turn you down if your credit score falls short. While it’s important to keep building your business’s credit, focus on your personal score for the moment.
Why does bad credit affect my loan options?
Lenders want reliable borrowers. They want to see you repay your debts on time and in full. They want to know you avoid taking on irresponsible amounts of debt. They want to know how many different kinds of credit you have and how long you’ve been borrowing money. Your credit score summarizes this information for lenders, giving them an easy way to evaluate your trustworthiness as a borrower.
Because your business is small, lenders assume you’ll treat your company finances much like you do your own. If you’ve got bad credit, you may discover you don’t qualify for a lender’s larger loan products, low annual percentage rates (APRs) or certain repayment schedules. Financial institutions cimply don't want to risk that you might not repay a hefty loan.
What can I do to help my chances?
Your credit score is a major factor in your eligibility, but it’s not the only factor. Lenders also will weigh your business’s revenue against the type of loan you hope to secure and its APR. You should understand the “5 C's of Credit” that describe how your application will be evaluated and reveal what else might help you secure that loan.
- Character. Your credit history and score fall under this category. Fair or not, your past will be used to predict your future.
- Capacity. This describes your ability to repay the loan, and lenders will use your debt-to-income ratio and cash-flow statements to learn how your revenue stacks up against your outstanding debts. If your business has a healthy cash flow and isn’t already saddled with debt, you might win the trust of your lender despite that less-than-stellar credit score.
- Capital. What investments have you made in your business? Lenders want to be sure you won’t default on your loan. They’re looking for commitment and dedication, and a substantial investment on your part tells a lender you’re serious about the success of your business.
- Collateral. This is all about assets -- anything the lender could repossess if you default. Those assets might include real estate, equipment, inventory or accounts receivable.
- Conditions. Lenders will examine how you plan to use your loan and the broader context of your financial need. They want to see you’ve got a specific purpose for your loan and a vision for growing your business with this capital. They'll also do some due diligence on your industry (in case it's about to tank) and your business plan (on the off chance it raises any long-term red flags). If you’ve done your homework to exlain how you'll budget for the loan, you’ll be more likely to win your lender’s trust.
How can I improve my credit?
If you’re feeling discouraged about your credit score, remember it isn’t set in stone. You have the power to start improving it today, even if you’re in debt for the foreseeable future.
The simplest way to maintain a healthy credit score is by making your debt payments on time and in full. This applies to your business loans as well as your personal affairs. Make sure you’re timely with any mortgage, rent, utilities or credit-card payments, as they all affect your personal credit score. Keep your credit use under control. Spend conservatively when using credit, and avoid maxing out all your available options.
You also should actively monitor your credit. Take advantage of that free annual credit report, and consider signing up for a credit-monitoring service. Free services such as Credit Karma will track your status across the three main bureaus and alert you as your score changes.
Having poor credit never feels good, especially for an entrepreneur trying to get a small business off the ground. The more you know about your personal spending and its impact on your business, the better equipped you’ll be to get your business back on the path to success.