- Payment history – 35%
- Utilization – 30%
- Length of credit history – 15%
- Recent activity – 10%
- Credit mix – 10%
If you’re a business owner who applied and was turned down for a small business loan because of bad credit, you probably discovered the importance of your personal credit score the hard way. Even if you have built a business credit score, unless you have been in business for several years, most lenders will also check your personal credit score when you apply for business funding.
Personal and business credit often dictates the rates charged, the terms of repayment, and the fees you pay to access capital. As a small business owner, you cannot afford to ignore the significance of both of your credit scores.
If you are just starting out, lenders are likely looking at your personal credit score. Your business does not have enough history to generate data for a business credit score. If your personal credit is not great, improving it will lead to increased access to the capital you need to run your business. Before you can start repairing your credit score, you need to understand it. Credit bureaus calculate your credit score using how much credit you have outstanding, and how much you are utilizing, your credit mix, payment history, the length of your credit history, and recent activity. The break-out of the components of your credit score is as follows;
FICO has indicated that they will be making changes to credit score calculations in 2020. In the future, rising debt levels will hurt your score more, as will late payments. If you already have a low score and continue to miss payments or incur black marks against it, it will trigger a bigger score decline than previously. To repair or build your credit score, you must tackle each of these categories.
The components of a business credit score relate to how a business handles its finances, rather than a person. Business credit bureaus include; Dun and Bradstreet, Experian Business, Equifax Business, and Business Credit USA. They each pull different information, and creditors do not always report data to them directly. A business credit score factors into its calculation credit obligation information, legal files, and background information from public offices. Because industries vary, its components are not as set in stone as a personal credit score and do not break down into simple percentages. Individual FICO scores range from 300 to 850, but business credit scores go from zero to 100.
When calculating your score, credit bureaus could look at collection actions taken against the business, payment history, the number of lenders you have worked with along with the credit they extended to you, and your repayment history. This score represents your business’ creditworthiness and tells lenders if you are likely to repay a loan.
In general, everything they consider will relate in some way to the following:
Whereas you can pull your personal credit score once a year for free, you will have to pay to access your business credit score. Fees range from $149 to $179, and you have the option of checking your score once, monthly, or annually.
It’s a good idea to start building a business credit score and manage your finances successfully from your business’s inception. Building a business credit score will help you qualify for small business loans and other types of business funding later. While you might have to personally guarantee a loan now, in the future, a great business credit score could allow you to avoid a personal guarantee. This reduces your personal risk and also might increase your borrowing power. It is important to create separation between your personal and your business finances for tax and liability purposes. The actions you take to build a business credit score will help with this, from opening business bank accounts, which make expense tracking easier to using a business credit card. A business credit score that is healthy can also help you maintain and establish relationships with suppliers. With it, you can obtain trade credit to buy inventory now and pay for it later, which could make managing working capital easier. Ultimately, a business credit score opens up channels to access additional capital and further insulates your personal life from your business.
Repairing your personal credit score starts with knowing what appears on your report.
First, you’ll need to get a copy of your credit report. Each of the three major credit bureaus, TransUnion, Experian, and Equifax, are required by law to give you one free copy every year by going to the annual credit report website. Also, if you apply for credit, you can request that the lender send you a copy of the credit report that they pull when making their lending decision if you have already used your free reports. You can also pay a small fee to access your credit report online or sign up for a credit-monitoring service, which gives you a copy for free when you sign up. Examine your reports carefully. Did a credit card incorrectly report a late payment? Do any accounts appear that you never opened? A study done by the Federal Trade Commission found that over 5% of consumers had errors on their credit reports. If you are trying to repair your credit score, do not skip this step.
You have the right to dispute any mistakes on your credit report. Send a letter and any supporting documentation, such as screenshots, canceled checks or bank statements, to the credit bureau. They have 30 days to respond. Unfortunately, you will have to send a letter to each credit bureau. They do not communicate with one another. If the mistake appears across all three reports, mail out three letters and keep track of when you mailed them and the documentation you sent. While you can now dispute items online, we recommend sending letters certified mail so that you will have a paper trail of the dispute.
If the problem originated with a bank or credit card, it’s also a good idea to contact the company providing the information to the credit bureau. Be polite, but firm, and have proof of payment activity to support your claims. Ask them to remove the negative information from your report. It can take several attempts to have errors fixed, so be patient.
Even if you never paid that last cable bill, and it is your fault that it now appears on your credit report in collections, it does not necessarily matter. If the missed payment occurred more than seven years ago, it should have aged off your credit report. Because credit bureaus know that people’s financial know-how changes over time, they have established time periods, after which negative information rolls off your report. However, many debt collection agencies sell debt to another agency. When a new agency buys your debt, they may try to re-age it. Start the timeline at the date they purchased the debt. They can also do this if you arrange to start paying on an old debt, so be careful before setting up any payment plans with older creditors. The Fair Credit Reporting Act does not allow the re-aging of past due accounts, and if you see something on your report that is older and should have rolled off, you have the right to dispute it. Getting it removed could see your score shoot up several points.
If you do owe the debt and it hasn’t been seven years yet, it will be harder, but not impossible, to make it go away. In a pay for delete letter, you offer to pay down debt, and in return, the collection agency will delete it from your credit report. These are effective in cases where you moved, for example, and never got the final bill. Or if you had medical bills that you thought your insurance company had paid. With this letter, you are paying the debt to the creditor or collection agency in exchange for their agreement to delete it from your credit report. There are some risks in a pay for delete letter. A collection agency is not obligated to follow through and ask the credit bureaus to remove the information. If they sell your debt to another agency, it could reappear. Try to get any agreements in writing.
Pay for delete letters are considered shady in that they game the system. You did, in fact, not pay a bill or paid it late, even if you have now paid it in full.
Learning how to build your personal credit score also teaches you financial skills that apply both to your personal and professional life. Much of what you must do to increase your score also relates to what you did to repair it.
Payment history makes up 35% of your credit score, which is why paying your bills late can have such a negative impact. If you struggle to remember when your minimum payment is due, set up automatic payments and text alerts. Consider consolidating some of your debt in order to have one monthly payment rather than having to keep track of many creditors.
It will take time for late payments to disappear off your credit report and for your new, on-time payment history to be reflected. It’s important not to get discouraged. Maintain your new payment habits in order to both fix your credit history but also avoid damaging it again in the future.
Higher balances on revolving lines of credit drag your score down. Lenders worry that you will not be able to meet your outstanding obligations and are hesitant to lend more.
One of the simplest methods to improve your credit is to start paying down credit card and loan balances. But when you decide where to send your payments, consider your credit utilization.
While conventional wisdom says that you should pay down higher-interest debt first, you will need to follow a different tactic if your goal is to repair your credit score. To the credit bureaus, credit utilization matters more than the rate you are paying on your debt.
They look at the percent of credit utilized when calculating your score. For example, if you have a credit card with a thirty thousand dollar limit and you’ve charged fifteen thousand dollars, your credit-utilization on that card is 50%. If you have another card with the same limit and only five grand charged, your credit-utilization is only 16%. It’s not hurting your credit as badly as the first card. To improve your personal credit score, calculate the credit utilization rate for all your outstanding lines of credit, list them from highest percentage to lowest, and begin paying down the higher ratio lines of credit. Before getting strategic about where to send additional payments, however, get current with all your accounts. Getting past due balances current should always be the priority.
It sounds counter-intuitive, but opening more credit lines can improve your credit score. When calculating credit utilization, the amount of credit used is the numerator, whereas the amount the amount of credit is the denominator. Paying down balances impacts the top number of your credit utilization ratio, and having more access to credit impacts the bottom.
Credit bureaus look at both credit utilization on individual cards and your overall credit utilization rate. In the above example, taking out another credit card with a $15k limit raises your overall access to credit to 70% and drops your total credit utilization ratio down from 33% to 29%. This is also why you should keep old accounts open even if they have no balances. If you could not pay down the fifteen thousand charged on the first credit card in the above example, you could call and ask for a credit limit increase instead. An increase to thirty-five thousand would drop your credit-utilization ratio to 43% without you making a single payment. Alternately, you can apply for and open more credit cards. A word of caution, however, when using this strategy. The number of recent credit inquiries can negatively impact your credit score, and since the length of your credit history is also a factor opening many new accounts can lower it, too. As well, the more credit you open, the more the risk of non-payment, so you will pay more in interest and fees for those additional lines.
While the amount of credit that you have available matters so, too, does the type of credit. Your credit mix is the mix between installment loans and revolving lines of credit.
An easy way to differentiate between the two is to think of installment loans, such as mortgages, car loans, and student loans, as having a fixed monthly payment. Revolving loans, such as credit cards and lines of credits, have variable monthly payments, which depend upon the amount you’ve drawn and other factors. Lenders want to know that you can manage both types of credit. Mortgages and car loans are viewed as more favorable debt because they have lower interest rates, fixed payments, and are secured by collateral. When deciding where to pay down debt, you should look at your revolving credit first.
Paying on-time, credit utilization, and your length of credit history matter have an impact on your business credit score. Fixing it will follow many of the steps involved in fixing a personal credit score.
Obtain copies of your business credit reports and examine all outstanding debt to see how it is impacting your score. If you have opened too many accounts, the credit bureau might consider your business overextended. Consider consolidating your outstanding business loans and pay them on time. Check that any debt you have paid off has been reported as closed to the credit bureaus. Lenders are not required to report account closures, and the credit bureau’s information on outstanding loans could be out of date.
If you have been struggling to make payments on your outstanding loans, contact your lenders. Ask them if you can set up a payment plan, or ask them to work with you on repayment terms. Many might be willing to restructure your debt rather than risk your business going under. Once they have set up a payment plan or agreement with you, stick to it. You do not want to harm the relationship further, and you must avoid further late payments from damaging your credit. Ask if they would be willing to remove negative information from your report after you have paid on time for several months or consecutive payments.
A positive trade reference can help balance out a black mark on your score. Ask suppliers and vendors to share positive references that you can add to your Dun & Bradstreet file. They may not even share their payment data with the bureau, but the positive reference will help build your business’ credibility.
To build business credit you will have to be intentional. Many of these steps are one-time actions that must be done before following general principles of sound financial management.
When you register your company with the IRS, you will receive an Employer Identification Number or EIN. This number allows the credit bureaus to track your business’ activity more closely. Depending on the type of corporation structure you have chosen, S-Corp, LLC, or C-Corp, this provides further legal and financial protection for you personally. Once you have this number, you will no longer have to supply your personal social security number when applying for business credit. You should also register for a Data Universal Number System or DUNS with Dun & Bradstreet. This unique identifier also helps with tracking your activity, and it is free. Their Paydex score is the business credit score most creditors reference, and registering with them ensures that they will begin tracking your activity and building this score.
Doing business on your dining room table might have worked for a while, but it is now time to have a dedicated business address and phone number. You will need them to sign up with the Better Business Bureau. Credit reporting agencies pull information from the BBB and online directories, so it will help build your score to have a relationship with them.
Next, open bank accounts in your business’ name using this EIN number. If your account shows enough cash inflows and outflows, or your opening balance is high enough, the bank may be willing to open a credit card or linked line of credit despite your personal credit score. If you have not done it already, incorporate your business or set up an LLC to further separate its activities from your personal banking.
Remember, credit bureaus need history to calculate your score. If you have never opened a business credit card or taken out a loan, they have no information about your repayment ability. Even if you do not have a pressing business need for a loan, opening a short-term loan and then paying it off could boost your business credit score.
Establishing trade accounts with suppliers can be a great way to build credit. With a trade account, you can accept delivery on inventory and pay for it at a later time. The vendor is essentially extending credit to you while you sell the inventory, though it is not a loan.
Pick vendors that report to the credit bureaus when opening trade accounts so that the relationship will help your score. And, once they have extended you credit, pay their bills when they come due.
A credit score is not meant to punish you, nor is it a reflection of whether or not you are a good person. Handling and managing credit effectively is a skill set. Once you have gained these skills, you are on the path to a new and improved credit score and a guaranteed approval on your business loan application or any other type of credit you are seeking. Here is some additional information on building your credit as well as another resource that can help with improving your credit.
