Starting your own business is exciting. You’ve broken free from the 9 to 5 grind and are starting your own venture. But, you’ll need capital. Do you have it? If not, you may need funding and funding requires a good credit score.
It sounds crazy, but you need a good credit score to start a business. You are starting with nothing – a bank needs to know that the person borrowing the money has what it takes to pay it back. Because your business doesn’t exist yet, there’s nothing there for lenders to assess, which is why they turn to your personal credit score. Consider the following:
Ready to learn more about why your personal credit score is so important when you start a business? Keep reading below.
You may think that applying for a business loan has nothing to do with your personal credit score, but it does. It’s still YOU taking out the loan. It’s still YOU responsible for paying the loan back in full. You can see why lenders would pay close attention to your personal credit score, even if they do use your business credit score (when you have one).
If you’re just starting your business, it doesn’t have a business credit score. This puts even more emphasis on your personal score and the reasons why it must be a good score. Lenders know that you need the money to start up, so they need to know that you are a good borrower that has good financial responsibility. If they gave money to just anyone – banks would be out of business pretty fast.
Knowing that you need a good credit score to start a business begs the question, ‘what is a good credit score?’
The answer varies by lender as each lender has its own requirements. In general, though, credit scores fall into the following tiers:
Do you need ‘excellent’ credit to get a business loan? You probably don’t, but you should fall somewhere in the ‘good to very good range.’ If you are in the ‘fair’ range, you may find some possibilities, but typically at much higher interest rates and fees.
Again, each lender has its own requirements. It’s important to shop around and see what lenders require. Having a good understanding of what lenders need will help you determine where you stand, what you need to improve, and how hard it may be to get the funding to start your business.
Lenders look at your personal credit score to determine your financial responsibility. How well do you manage your debts? Do you pay your bills on time? Do you overextend yourself financially?
If your credit score and credit report show poor use of your credit, you may not be a good candidate for a loan to start your business. Of course, your credit score isn’t the only factor lenders consider, but it’s one of the first.
If you have a good credit score you’ll likely get:
If you have ‘bad or poor’ credit, you may not be able to borrow as much as you need and it will likely cost you a lot more. Lenders may charge higher interest rates or charge more fees. They may also give less lucrative terms. For example, you may only be able to secure a short-term loan with a balloon payment rather than a longer-term fixed-rate loan.
If you’re thinking of starting a business, it’s crucial that you maximize your personal credit score. Knowing what makes up the score can help you maximize it.
Your credit score includes the following:
35% payment history – How well do you make your payments on time? Every time you make a payment more than 30 days late, it’s a hit on your credit report. At 35% of your credit score, even one late payment can have a drastic impact on your score.
30% amounts owed – How much do you owe compared to your credit balances? Credit bureaus prefer this number at 30%. In other words, you shouldn’t have more than 30% of your credit balance outstanding at one time. Anything over 30% is a sign of financial irresponsibility. Ironically, this is 30% of your credit score too.
10% credit mix – Do you have a decent mix of the types of credit? In other words, do you have all credit cards (revolving debt) or do you have a mixture of revolving debt and installment debt (auto loans, personal loans, etc.)?
15% length of credit history – How old is your credit? It sounds odd, but it’s a thing. Credit bureaus feel that the older your credit is the better picture they have of your financial responsibility. That’s why it’s important to not close old accounts even if they are paid off – just leave them open to help your credit get ‘older.’
10% new credit – Every time you take out new credit, it can hurt your credit score. While it’s only 10% of your score, keep it in mind every time you apply for another credit card or loan. If you get it, your credit score may drop slightly. Plus new credit brings down your credit age, which also decreases your credit score.
As we said above, your credit score isn’t the only factor lenders look at when approving you for a loan to start your business, but it’s the first. Always work on your credit score and credit ‘thickness’ first. If you don’t have enough credit, consider a credit builder service to beef up your credit so that the credit bureaus can give you a score.
Applicants without a credit score at all have a very slim chance of securing approval for a loan to start a business.
In addition to your credit score, lenders often look at:
Your employment history – Even though you’re applying for a loan to start a business, lenders need to know that you have the knowledge to succeed in the business. The bank takes a gamble when they lend you money to start a business. They want to know that you are an ‘expert’ in what you are about to start.
Your debt ratio – If you are in over your head in debt, lenders won’t give you another loan even though it’s to start a business. Starting a business takes time as does waiting for it to create a steady income. If you are already knee-deep in debt, you have to get yourself out of it before a lender will give you funds to start a business.
Your assets – It’s always a good idea to have collateral for your business loan. Lenders are more willing to give you the loan when they know they have something to fall back on should you default. While you probably don’t want to put your house on the line, think of other assets that may serve as collateral to show your seriousness in starting a business.
Starting a business is expensive and chances are that you’ll need help getting the capital. It’s important that you maximize your personal credit score as one of the first steps to getting the funding you require. Without a good credit score, you’ll have limited options, not to mention expensive options that may be out of your league. Take control of your credit score right away!