You may not realize it, but your personal credit score matters to your small business. Lenders pull your personal and business credit score when considering applications for small business loans. Both profiles reveal information about your ability to handle credit.
Continue reading to learn more about credit scores and their impact on lending decisions.
What Is a Personal Credit Score?
A personal credit score is a number that reflects your credit history. Credit scores range from 300-850. High credit scores is an indication of healthy credit, it means that you will most likely qualify for loans with the lowest fees and interest rates. Many banks only extend credit to consumers with excellent credit.
If your credit score is not good, a lender may still approve you for a loan, but you will not be offered the most favorable terms. Prospective employers may also look at your credit score to determine your level of responsibility. A poor credit history could indicate that you are irresponsible.
Personal Credit Scores Explained
Your personal credit score is determined by the three credit reporting agencies – TransUnion, Experian, and Equifax. They collect information from your creditors, including landlords and utility companies. Based on the information, they calculate a credit score. Although the three agencies use slightly different algorithms, the typical range is as follows:
- Excellent: 800-850
- Very Good: 740-799
- Good: 670-739
- Fair: 580-669
- Poor: 300-579
Your personal credit score is calculated based on five criteria.
- Payment history: account for 35% of your credit score. Late payments, defaults, settlements, or liens are among the actions that are included in your payment history
- Credit utilization: account for 30% of your personal credit score. A high credit utilization percentage is going to negatively impact your ability to obtain financing. Maxing out credit cards or using your entire line of credit will hurt your credit utilization ratio
- Credit history length: represents up 15% of your credit score. The longer your history, the more evidence lenders have of your ability to handle credit
- Types of credit: Lenders like to see a mix of credit, such as mortgages, revolving accounts, and installment loans. Types of credit represents 10% of your credit score
- Credit inquiries: Although it makes up only 10% of your credit score, the habit of frequently applying for financing could hurt your credit score. Especially problematic are credit card applications which might indicate financial problems
Why Business Lenders Care About Personal Credit
Your success in securing small business loans is going to be influenced by your personal credit score.
- Business loan lenders have three basic concerns: Are you able to repay the loan? Will you repay the loan? Will you make the loan payments on time and in full?
- Indication of your business creditworthiness: You may believe that your personal credit score reflects how you handle your personal credit responsibility, but small business lenders view it as an indication of your business creditworthiness. If you are sloppy with your personal financial obligations, how can they know that you will not also treat your business financial obligations the same way?
- Lack of business credit history for new businesses: Many lenders and credit agencies do not regularly report business lending activity. Your personal credit score is going to be the only resource available to lenders when considering your application for a small business loan
- Lenders are particularly interested in the amount of personal debt you are carrying: Even though it is a business loan, lenders may have doubts if you are over-leveraged with personal debt. Too much personal debt could also cause lenders to worry that you might use your business proceeds to cover personal expenses
Why Poor Credit Hurts Your Small Business
- The Federal Reserve Bank of New York reports that the success rate for small businesses applying for loans is less than 50% and poor credit is the chief reason.
- A poor credit score can kill your dreams to become an entrepreneur. You need capital to fund startup costs. If your personal credit score is poor, banks or other investors may not want to extend capital
- If you need an office, retail space, or warehouse for your business operations, your poor credit score could hurt your leasing application success rates. Utility companies also evaluate your personal credit score when deciding whether you qualify to open an account
- Your credit score impacts the financing terms you are offered. You will be forced to pay higher interest rates, increasing the total amount of financing that must be repaid. This puts added stress on your long-term business financial health
- If you have a poor credit score you might not qualify for a business credit card. If you do find a carrier willing to issue a business credit card, it will come with many restrictions and a low credit limit
- A poor credit score can impact your ability to get credit from your suppliers. It helps your cash flow to have a couple of months to pay for the inventory. Suppliers usually review your personal credit score before extending credit to you. A poor credit score could prevent you from securing important inventory or equipment
Your personal credit impacts your ability to run a successful business. A poor personal credit score is going to impede your ability to secure loans to start a business, expand operations, purchase inventory, or cover cash flow gaps. Poor personal credit could even result in higher operating costs, so keep an eye on your score.