Are Business Loan Approvals Based on Personal Credit?
The magnitude of your personal credit’s effect, however, depends on other factors too. The most significant of these factors include:
- The type of lender, loan, and collateral
- The terms and amount of your loan
- Your business’s debt repayment history and capacity to repay
- Your business’s capital structure
- Current economic conditions
These five factors, along with your credit score, are what lenders use to determine the overall risk of lending to you.
If these five factors show that lending to you isn’t risky, your personal credit score is less important. However, if you don’t score well on these five factors, your personal credit becomes more significant.
Still, even if your personal credit doesn’t stop you from getting approved, it can make the loan cost more expensive. So, if there’s room for improvement in your credit score, it’s certainly worth pursuing.
To help with that, we’ll review how you can boost your personal credit prior to applying for a business loan.
How to Improve Your Personal Credit Score to Get Approved for a Small Business Loan:
1. Understand How Personal Credit Scores Are Calculated
By understanding the numbers behind your personal credit history, you can get an idea of how to improve your score. The following is a breakdown of how the most common credit score, the FICO Score, is calculated:
- Amounts owed: 30 percent
- Payment history: 35 percent
- Length of credit history: 15 percent
- Credit mix: 10 percent
- New credit: 10 percent
The percentages listed above represent how important each category is in determining your score.
2. Make Your Payments On Time and In Full
As you saw in the previous point, the most important factor affecting your personal credit is your payment history.
Therefore, if you make a habit of paying your debts on time and in full, you’ll have a better credit history. As a result, you’ll be more likely to get approved for a business loan or other financing options such as merchant cash advances or lines of credit.
If you’ve had a history of missing or late payments, all is not lost if you start making your full payments. By doing this, you can bring your score back up and in turn improve your overall finances. Of course, the more missing or late payments you have, the longer it takes to bring your score back up.
3. Formulate a Long-Term Plan
Let’s say your credit mix, payment history, new credit, and length of credit history are all good. The only problem is you only have one credit card with a limit of $5000. Due to this, you use 60 to 80 percent of your limit each month.
Because you’re using almost all of your credit each month, your score will suffer. To fix this, you could either request to increase your limit or look for an additional credit card.
If you get a new credit card, you’ll have more credit, but your score may go down because you added new credit. As time goes by though, that new credit will age, your amounts owed will decrease, and your score will likely go up.
All this to say, it’s important to look at your credit improvement efforts in the long-term. The more time you give yourself, the more options you have to improve your score.
4. Check Your Personal Credit Report for Errors
In a study by the Federal Trade Commission (FTC), 27 percent of participants found at least one error on their credit report. To check your report for errors, you’ll need to request your report from each of the three main credit bureaus, Equifax, Experian, and TransUnion.
If you find an error, you should gather documentation and write a letter disputing the error. Then, send your letter and supporting documentation to the credit bureau and the lender who reported the incorrect information.
For more on fixing credit reporting errors, USA.gov provides useful information on their Credit Reports and Scores page.
5. Don’t Drag Out Your Loan Shopping
When you shop for a loan, alternative and online lenders conduct what’s called a hard inquiry on your credit. This means that the lender has requested your credit file so they can evaluate your creditworthiness. Hard inquiries appear on your credit report and negatively affect your credit score for a short time.
If you’re shopping for a loan, hard inquiries are unavoidable. Therefore, the key isn’t to avoid but to limit the impact of hard inquiries. To accomplish this, you should make sure they occur infrequently.
When you shop for loans, do so only over a short, focused timeframe. This helps because the credit bureaus recognize that you’re submitting multiple applications to compare rates. Due to this, the bureaus treat it as a single hard inquiry.
If you compare interest rates and other factors over a longer period of time, you’ll have multiple hard inquiries, which will hurt your score and overall business finances.
Conclusion: Your Personal Credit Matters When Pursuing Business Loans
We’ve addressed how personal credit affects your business loans, but what about the opposite? That is, does a business loan affect your personal credit?
As you may have guessed, it depends on your business’s situation. If you’ve personally guaranteed a business loan, or if you’re a sole proprietor, your business loan will affect your personal credit. Additionally, though many business credit card providers don’t report to consumer credit bureaus, they will if you miss a payment.
Ultimately, your best bet is to pay your bills on time, keep your balances low, and educate yourself. The more you know about how credit scores and business loans work, the more empowered you will be to take action.
Editorial Note: Any opinions, analyses, reviews or recommendations expressed in this article are those of the author's alone, and have not been reviewed, approved, or otherwise endorsed by any of these entities.