If you’re already an entrepreneur or a “wantrepreneur,” which is someone who is yearning to start a small business, you know that raising funds is key. You have to spend money to make money and for many start-ups, no matter your size, that can mean taking out a personal loan. When you open a sole proprietorship, banks and other lenders see you and your business as the same so your personal credit score determines whether you can borrow to finance your business.
Personal vs. business credit score
Creditors rate well-established businesses on their own merit. Dun & Bradstreet offers a business credit rating, but if you’re just out of the gate, this option isn’t open to you. Lenders will judge the ability to pay back funds it loans on your personal history of financial responsibility. That’s one of the many reasons your credit score is so important. Once your business has been around a few years and grows to medium-sized with an independent financial track record, your personal credit will come under less scrutiny.
What credit score do you need for a business loan?
As with any loan, different lenders have different criteria and expectations. With credit scores ranging from 300 (very bad) to 850 (excellent), lenders will expect you to fall into the range of good credit. You’ll need a minimum credit score of at least 550 to get a business loan. Plus, the higher your credit score, the lower your interest rate should be, so that’s an important consideration.
What determines credit scores?
Your credit score is a calculation based on your credit report which is a history of your credit activity. There are five components to a credit score:
- Payment history makes up 35% of your credit score
- Balances owed determines 30% of your score
- Length of credit history accounts for 15% of the score
- New credit determines 10% of your credit score
- Mix of credit types accounts for 10% of your score
It’s easy to see that payment history and balances owed drive most of your credit score. It’s vital that you pay all your bills on time each month, particularly those that report to the credit bureaus such as credit cards, mortgage, and auto loans. The balanced owed considers how much of your total lines of credit that you’re using.
If you’re using more than 25-30% of your available credit, your score will drop. If you miss even one payment or make one late payment, your credit score will drop. If these conditions continue, your credit score will drop every month until you get your finances in order. These personal habits can make or break your ability to find your small business.
How can you quickly improve your credit?
For those that own a business and need financing or are planning to start a business, getting your personal financial house in order is step one. Always pay your bills on time, never charge more than you can pay off in a month, and don’t feel like you need to use your credit cards just because they’re in your wallet. Credit cards are a useful tool to build credit but can be a slippery slope.
The fastest way to improve your credit is to get negative items off your report, pay down balances, and pay on time. If you have negative entries or collection items, work with the creditor or debt collector to resolve the issue on the condition that they’ll remove the item. Tighten your belt, pay off card balances, and don’t run them up again. Finally, set a budget, stick to it, and always pay on time.
If your credit score is lower now because you are coming out of bankruptcy or had a financial hiccup, rebuilding it as soon as possible benefits you and your small business. Check out Credit Score Keys for more info on re-establishing your credit and getting a better credit score.