How to get a Business Loan with Bad Credit
Access to capital helps small business owners manage working capital and expand their business. It can spell success, or doom, for a struggling business owner. But it is not easy to obtain.
Traditional lenders have strict requirements to qualify for a business loan, and often will not lend to those with credit scores below 750. They also prefer to work with businesses who have been successfully operating for many years, showing growth, and already have strong cash flow. It’s an old joke but true, often to get approved for a loan with a bank you need to prove that you do not need it.
The reality is that many successful small business owners may not have great credit, even if their business is doing well. When a bank loan is not an option, alternative lending becomes a valid business funding source and for many small business owners alternative business loans are a better option.
Alternative lenders specialize in working with those who have been denied for funding at banks. They exist to help small business owners succeed. Here is how to qualify for a business loan with bad credit.
Why do Lenders Avoid Lending to Business Owners with Bad Credit?
Many lenders view your credit score as a reflection of risk. To them, a lower credit score indicates that you lack financial management skills and could make late payments or default on a loan.
This is largely because of the components that go into calculating a credit score. If you make payments late, points are deducted from your overall score. Defaulting on a loan, or frequently overdrawing a checking account, also negatively impact your score. Lenders worry that you will engage in the same behavior if they extend credit to you.
A low credit score can also be caused by simply not having enough data. If you have paid cash for most of your life, or are younger and have yet to build credit, the credit agencies do not have enough data to build a score. In an odd way, you are punished for not using credit and being able to meet your expenses with cash.
The first thing to consider before applying for your business loan is to see if there is any way you can improve your credit score.
How quickly can you Fix Bad Credit?
There are actions you can take to improve your bad credit score, but it is not a fast process. It can take up to seven years for a late payment to fall off your report, and a bankruptcy can take up to ten years. In the meantime, you can take steps to improve your score that do not depend on erasing the past.
Set up auto-payments for all your bills so that you never make a late payment again. Work to reduce your debt to income ratio and your debt utilization ratio, which will push your credit score higher. For more information, read our business owner’s guide to repairing your credit.
Alternative lenders understand that because it takes so long for past mistakes to fall off a credit report your credit score may not reflect your current financial management skills. It is for this reason they offer business loans with poor credit. Their credit score requirements are much lower than those at traditional lenders, and for some products they will lend to those with scores as low as 500. Instead, they consider other factors when deciding whether or not to underwrite a loan.
How to Meet Alternative Lender Requirements
If you want to get a business loan with bad credit, you will have to meet the requirements of an alternative lender. To improve your odds of being accepted, take the following steps.
One of the major factors for alternative lenders in making lending decisions are your monthly revenues. They look at cash flow to measure your repayment ability. For bad credit business loans the lender will want to see minimum monthly revenues of $8,000, for short term business loans $10,000.
If you know that you will have to apply with an alternative lender, work to increase your monthly revenues. Run specials and sales contests, and boost your marketing efforts on free social media channels. Ask existing customers to write positive reviews on online sites such as Yelp to help attract new customers.
You can also try to generate more revenues from existing customers. Examine their businesses and see if you can add on more services or products to deepen your relationship. The success rate on selling to new customers can be just 5-20%, whereas it jumps to 60-70% if you are selling to an existing customer.
To qualify for a business loan with bad credit, make sure that you meet a lender’s revenue minimums before applying.
Alternative lenders will likely ask to see several months of bank statements as part of your application process. They want to confirm that your business is cash flowing regularly and thus can support repayment. Try to maintain consistent daily and monthly balances.
Before applying for a bad credit business loan, make sure that you go several months without overdrawing or incurring non-sufficient funds (NSF’s) on your account. Try to leave as much cash as possible in your checking account, or link it to a savings account to avoid overdrafts.
Consider incentivizing some customers to pay on time, rather than over several months, to show all their revenue in one month. Offer terms such as Net 10, which is a 10% discount for paying in full within ten days. You want to show strong revenue each month.
Improve your Financials
Look at your debt to income ratios and other financial measurements to identify opportunities for improvement. A debt service coverage ratio is the amount of your current net income that must be put towards debt payments. Lenders consider this ratio when determining whether or not you could take on more debt. Simply paying down existing debt will improve it.
If your DSCR ratio is decent, consider your debt utilization ratio. This is the amount of your available capital you are currently using. Say you have a credit limit of $20,000 on a credit card and have a balance of $15,000. Your debt utilization ratio is 75%. Paying down the balance, or even transferring it to another card, could improve your ratio.
Alternative lenders have their own set of underwriting requirements which verify a business owner’s credit-worthiness separate from a credit score. Working with them, a small business owner with poor credit can qualify for the business funding they need. Following these steps will help guarantee your business loan approval.