With theU.S. economy expanding,credit relatively inexpensive, and low corporate tax rates encouraging capital investment, this is a great time for small business owners to take out a loan to finance growth.
However, small business owners can significantly improve their chances of getting a loan approved by first taking steps to boost their personal credit score.
The biggest factors that any bank looks at when deciding whether to approve a loan arethe 5 Cs of credit:capital, collateral, conditions, cash flowand creditworthiness. For young companies, consultants operating as solo practitioners, and early-stage startups, that creditworthiness component leans heavily on the owner’s personal credit.
So, making sure your personal credit score is as high as possible will give the company the best chance that an application for aU.S. Small Business Administration-backed loan will get approved.
Understand your creditscore
The first thing to note is that theFICO scoresof the national credit bureaus --Equifax, Experian, and TransUnion --use a different method than banks. For example, Experian uses a FICO 8 score, a different methodology from the FICO 5 score banks use. The FICO 8 scores creditworthiness on a 300 to 850 scale while the FICO 5 scores from 334 to 818.
FICO 5 scoresare weighted 35% for payment history, 30% for the amount of available credit used, and 15% for the length of credit history, with credit mix and new credit applications each weighted at 10%. Typically, small business lenders want to see scores above 680 to consider an applicant. However, business owners with borderline credit scores can take some smart steps to boost their score by 50 points or more.
1. Establish agood payment history
That starts with allowing loans to “season,” in banker parlance. Bankers like to see loans such as mortgages in place for several years. It’s OK to refinance a mortgage every few years, but doing so every year gives the appearance of using a home as an ATM and hurts a credit score. 58003 Making that change could, for example, improve a credit score from 650 to 710.
2. Manage credit use wisely
Banks like to see that more than 70% of credit capacity is available. people using 50% or more of credit availability are viewed as marginal, while those with 30% or less of their available credit are viewed as a poor credit risk. For someone with a credit availability of $10,000, it makes a huge difference whether they carry $7,000 of debt or pay it down to $3,000. That lower balance can often be achieved as easily as paying a credit card statement a few days earlier than usual.
3. Keep credit accounts open
people often make the mistake of paying down a credit card to reduce their debts and then close the account. paying the card down could improve a score by 8 points, but closing the account reduces the amount of available credit, which could reduce a score by 20 points.
4. Types of debt matter
When it comes to credit mix, banks prefer secured debt such as mortgages, but having a blend of debts, ranging from a mortgage to a home equity line of credit and credit cards helps.
All of the credit bureaus are required to give consumers one free report annually, so business owners should request a report from one bureau every four months to stay on top of any issues that may arise.
5. Address any blemishes
These days, with doctors outsourcing their billing, insurance-related collections are a major source of nuisance on credit reports that can often be fixed with a few phone calls or by making some payments for overlooked, outstanding charges. By checking reports, consumers can also find errors and dispute them.
Consumers often find accounts that were charged off, perhaps when an interest charge accrued after an account was closed. 58003 Such action can clean up a credit score in a few months.
Notallproblems can be fixed, but most banks will overlook old medical collections, especially if they stem from a single issue, for example, a bankruptcy dating back more than 10 years ago that no longer shows on bureau reports.
When figuring out how much a small business owner can repay each month, it also matters what type of debt a person carries. For example, for $10,000 of credit card debt, most banks estimate a 5% monthly minimum payment, or $500, compared to a home equity line payment of about $46/month, or an unsecured 5-year term loan whose estimated payment would be $212/month.
Asurveyconducted by regional Federal Reserve Banks finds that getting a loan is the No. 1 challenge facing small businesses. That problem is particularly acute for smaller companies with revenues of less than $1 million. 58003 And it’s easier than many people think.