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How Bad Credit Affects Business Loan Applications

What credit score is considered?

Credit scores and the overall credit history that make up that score are a critical part of the borrowing process. Lenders use these scores to determine a borrower’s eligibility for a loan as well as the amount of that loan. Any borrower considering a business loan should understand the impact credit history has on a business loan application. There are many ways that bad credit can affect the business loan application process. Whether you can receive an approval, how long you can borrow the money for, as well as what you will pay for it can all be affected by your credit history. However, the actual impact bad credit has on the lending process is completely different than it once was. There is both business credit and personal credit as well as complicated credit score calculations. There are so many ways today that credit plays a role in the lending process and the more you know the easier it will be to borrow.

What is Business Credit?

Business credit consists of bank accounts, loans, and credit cards taken out in the business’ name. Often, you’ll need to supply your social security number to open these accounts. Obtaining an Employer Identification Number from the IRS, setting up an LLC, or using a state’s business tax ID number for business accounts helps you establish credit separate from your personal credit. Business credit is generally used by insurance companies and credit card companies to issue credit.

What is Personal Credit?

Personal credit, as reported by the major credit bureaus, is a score that measures your reliability in paying off debt, how much you owe and your likely ability to repay. Components of bad credit include frequently missed or late payments, a high balance to credit limit ratio on your credit cards, and too many open revolving lines of credit to name a few. Most lenders rely on personal credit when approving borrowers.

Credit Scores and Business Loans

Small business Administration or Bank Loans have the lowest interest rates and fees for borrowers considering a business loan. If you apply for funding from a traditional bank you will need stellar personal credit, as business credit will have little to no impact on traditional financing options. If your FICO credit score is below 700, you will likely have to apply to a non-traditional or alternative lender to get a business loan. Non-traditional loan providers also known as alternative lenders also consider your personal credit and not business credit when making a loan approval decision. These lenders offer higher cost shorter term loans for borrowers that either have bad credit or do not meet the qualifications of lower cost traditional financing.

The Bad Credit Effect

The bottom line is that if a borrower does not meet the highest standards for traditional financing that individual effectively has bad credit (or not good enough credit), and a shorter term business loan at a higher cost is probably the fastest and easiest option to secure funding for a business. It is important to note that there are many different levels of bad credit because alternative lenders do not utilize the same approval methods as traditional lending institutions. Unlike traditional lenders that determine either a credit score is good enough or not for their lending option, alternative lenders assign a risk profile based on several factors with credit history being just one of them. Instead of either yes or no like a bank, the higher the risk of the borrower’s overall application, the shorter the term, the lower the approval amount, and the higher the costs for the business loan.

What Alternative Lenders Look For

One of the major approval factors on a bad credit business loan application is the company’s financial health. Cash flow and the age of the business make up a big part of this. The cash inflows and outflows of a business demonstrate repayment ability. If the cash flow shows a clear pattern of ebbs and flows that always results in the ability to pay off the requested loan, the lender will be much more likely to loan the money no matter what the credit score looks like. Along with this is age of a company, if a business has been open for fifteen years, a lender is more confident that they’ll be repaid despite what a credit score suggests. Although credit history is important to get a historical perspective of a borrower’s ability to pay back a loan, alternative lenders are more confident in determining approvals by looking at a company’s financials and age. This is important because two borrowers, with the same bad credit history, can have completely different rates and terms depending on their business. The key for a business loan application is to polish up the rest of the package if it is known that the personal credit history is not that great.

How to Improve an Application

Even if a borrower’s credit history is extremely poor there are still bad credit business loan options available. Assets that can be put up for collateral on a loan application can help sway certain types of alternative lenders into an approval. With accounts receivable financing a company can borrow against its outstanding invoices until they’re paid. The main credit profile considered in this type of financing is that of the customer that owes the invoice. Lastly, alternative lenders try to look beyond a credit score and many of the negatives on an application. Certain industries have well known cash flow and seasonal cycles. An experienced lender, familiar with the ups and downs of a particular industry, might overlook a lot of derogatory information. Remember; lenders want to know how they’ll be repaid, when they’ll be repaid, and the likelihood of being repaid. There are some derogatory items that very few lenders will accept.

Automatic Disqualifiers for a Business Loan

There are other circumstances which are almost always automatic disqualifiers for a business loan, and these disqualifiers may or may not appear on a credit report.
These include;

  • child support
  • certain bankruptcies
  • tax liens without a payment plan
  • no social security card

Factors that make Qualifying for a Business Loan Harder

While these don’t automatically disqualify an individual from obtaining a small business loan, they’re guaranteed to make it harder. If an applicant has previously defaulted on a loan, rather than just missed or made a late payment, a lender views this as a red flag. A potential borrower should be prepared to present a reason for the default, whether it was a business partner that is no longer with the company or a family medical emergency that took the attention or resources from the business. The same applies if an applicant has too many outstanding loans. This may indicate that the business could be struggling, and no amount of cash inflows can save it.

The Best Bet to Getting a Business Loan with Poor Credit?

Understanding how personal credit affects business loan applications can make it easier for small business owners to qualify for a business loan. Small improvements to personal credit, combined with a strong focus on managing the company’s financials and business bank accounts can lead to a solid funding package when a business needs it.