How to Repair Your Credit for Business Owners
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 keep your business’ books separately from your personal finances and build business credit, most lenders will check your personal credit score when you apply for business funding. And your ability to access credit directly impacts your business’ future.
Personal and business credit often dictates the rates you are offered, the terms of repayment and the fees you pay to access capital. As a small business owner, you cannot afford to ignore its significance going forward, but what about in the past? If you think that you are stuck living with poor decisions that hurt your credit score, think again. Repairing your credit is possible.
Repairing your Personal Credit Score
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 component of your credit score is as follows;
- Payment history – 35%
- Utilization – 30%
- Length of credit history – 15%
- Recent activity – 10%
- Credit mix – 10%
To repair your credit score, you must tackle each of these categories. And it all starts with knowing what appears on your report.
Examine Your Credit History
Each of the three major credit bureaus, TransUnion, Experian, and Equifax, are required by law to give you one free copy of your credit report every year. As well, 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. 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.
Once you have your credit reports in hand, examine them 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.
Dispute any Errors
If you identify any mistakes on your credit report, you have the right to dispute them. Send a letter and any supporting documentation such as screenshots 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 careful track of when you mailed them and the documentation you sent.
If the problem originated with a bank or credit card, however, also contact the company providing the information to the credit bureau. Be polite, but firm, and have proof of canceled checks, payments through your bank account, or statements that show payment activity to support your claims.
While you can now dispute items online, we recommend sending your letters certified mail so that you will have a paper trail of the dispute.
Dispute Negative but True Information, Too
Yes, you never paid that last cable bill, and it is your fault that it now appears on your credit report as being 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.
However, many debt collection agencies sell debt to another agency. When a new agency buys your debt, they may try to re-age it. I.e., 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.
Pay for Delete Letter
You are not out of luck if you do owe the debt and it hasn’t been seven years yet, but it will be harder 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 which you thought your insurance company had paid.
There are some risks in a pay for delete letter. A collection is not obligated to follow through and ask the credit bureaus to delete 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.
Start Paying on Time
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.
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.
Reduce Balances on Outstanding Lines of Credit
Outstanding balances impact your credit score. Generally speaking, higher balances on revolving lines of credit drag your score lower. 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 loan balances. But when you decide where to send your payments, consider your credit utilization.
Analyze your Credit-Utilization
While conventional wisdom says that you should pay down higher interest debt first, follow a different tactic if your goal is to repair your credit score.
Credit bureaus 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.
Now, if the second card has a 15% interest rate and the first card has a 10% interest rate most debt management advisors would tell you to pay off the card with 15% interest first. While that makes sense from a debt management perspective, it doesn’t help your credit score as much as reducing the percent of your available credit that you have used on the first card.
To improve your personal credit score, calculate the credit utilization rate for all of 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. Past due balances should always be the priority.
Open another Credit Card
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 it 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.
Analyze your Credit Mix
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.
Generally speaking, 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.
Repairing your Business Credit Score
The same components that make up a personal credit score are input into a business credit score calculation. Paying on-time, credit utilization and your length of credit history matter have the same impact.
Keep your payments with vendors’ current, and avoid paying anything past due. If your business is struggling, see if you can work out payment plans and better terms. Set up a linked line of credit or savings account to cover overdrafts in your checking account. Pay down outstanding balances on any small business loans, particularly if you plan on applying for another one soon.
It can seem like magic, but repairing a business or personal credit score simply means proving that you can be trusted to pay your debts in full and on-time.
Building Personal and Business Credit
Some businesses have a different credit problem. No longer is it a good idea to pay for everything in cash and never finance business operations. Lack of information to input into your credit score can cause the same problem as negative information, a low score.
If you want to build business credit, open bank accounts in your business’ name. If your account shows sufficient 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 haven’t considered it already, look into incorporating your business or setting up an LLC to further separate its activities from your personal banking.
Taking out a short-term loan is an easy way to build your credit. Loan qualification requirements are often less stringent, and you’ll be able to demonstrate repayment history quickly. Even if you don’t necessarily need the money, the goal is to build a credit score.
Credit cards charge a higher interest rate than a short-term loan but do show up on your credit report right away. If you are having difficulty getting approved for a major credit card, try a retailer’s card such as at your local Macy’s. Store cards have easier approval processes.
Or apply for a secured credit card. With a secured credit card, you place money on deposit to secure the balance. While you run it through a machine just like a normal card the credit card company has a deposit from you on hold to cover those transactions. This, obviously, removes their risk.
Even if you think you will be able to continue paying all your bills in cash, eventually everyone needs credit. It is a good idea to build your credit score, and maintain it, even if you’re currently doing just fine.
Once you have gone to all the trouble of repairing and building your credit score, it is essential to maintain it. Continue the good habits that you formed when repairing your credit score. Keep paying your bills on time. Keep hard credit pulls to a minimum. Monitor your spending and charging habits and do not let your credit card account balances get out of control.
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 skillset. 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.
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