While a business loan is technically made to your business, most lenders will review your personal credit history when you apply for one.
When a lender is reviewing your loan application, there are many factors to consider that will determine whether you’ll be able to take on the debt. Your personal credit score gives them a more accurate picture of your ability to pay back your debts. It’s especially helpful for lenders to review if your business is newer and hasn’t established a business credit score yet.
Every lender has different credit score requirements, so it’s best to do what you can to increase your score before you apply. Here’s how to improve your credit score before applying for a small business loan.
What do lenders look for in your personal credit score?
Lenders want to know that you can manage your finances well and have the income needed to repay your loans. When your lender looks at your personal credit history, they’re evaluating your credit use, your ability to pay back existing and new loans, and whether you’ve paid off previous loans and other obligations.
They’ll also look at how much credit you currently have (the limits, as well as how much you’re using) and whether your payments are made on time. These criteria are commonly known as the 5 C’s of Credit: credit history, capacity, capital, collateral, and conditions. Taken together, these elements make up your personal credit score.
Know your credit score and history before your lender does
If you spot incorrect information, such as fraudulent charges or accounts , act immediately. It can take some time and effort to correct credit report errors, and the sooner they’re cleared, the sooner your score will improve.
How to improve your credit score
Your lender has seen a wide range of credit score issues for small business owners and has helped them fix their scores too. Here are a few of the most common issues and steps you can take to overcome them:
1. Your credit score is low despite a strong repayment history
If your score is low, but you’ve never missed a payment, it might be due to something else completely. One possible reason could be that you’ve been cautious in using your credit and haven’t established enough of history. On the other hand, you could have perfect repayment but also have outstanding debt balances that are more than 30% of your credit limit. This will inevitably lower your credit score.
There are a couple of easy ways to improve your score in this situation. The first is to pay down your balances so that you’re using about 20 to 25% of your total credit. The second is to call the credit card companies and ask for a credit increase. Increasing your credit limit is particularly helpful if you don’t carry high balances but they look high compared to your total credit limit.
For example, if you carry a balance of $300 and have $1,000 in total credit, then you’re using 30% of your available credit. But if you have that same $300 balance on a total credit limit of $2,000, it changes usage from 30% to just 25%. This would have less of a negative impact and can help improve your score.
A word of caution, though: don’t be tempted to open multiple credit cards to increase your total credit limit, especially store cards that carry high interest rates. Aim to maintain three to four credit cards, pay them on time and keep the balances in a healthy range, typically less than 30% of your total credit limit.
Once you increase your credit limits, don’t be tempted to use the extra credit unless it’s absolutely necessary. The goal is to maintain a credit usage percentage of less than 30%. Using more credit than you need will continue to lower your score.
2. Your credit report shows late payments.
On-time payments demonstrate that you take your debt obligations seriously, but even the most responsible person can slip up now and again.
A good way to prevent this is to set up auto-payments for your accounts. With auto-pay, the amount you owe is withdrawn each month, and you don’t have to worry about making payments on time.
For credit cards, set up your auto-payments to have the minimum due each month automatically withdrawn. This ensures that you’ll always make a payment on time. If there’s a remaining balance, you can make an additional payment before the next statement is issued.
3. Your credit report includes delinquent accounts
Delinquent accounts are your accounts that have gone to collections. These can include unpaid credit cards or utility bills that your original creditor has sold to a third-party credit collector.
If you’ve fallen behind on paying your debt, you’ll need to reach out to the creditor to establish a payment plan before they send it to collections. Always be proactive in communicating with a creditor. If you’re facing a challenging time that will affect your payments, reaching out to them as soon as possible to come up with a solution makes the impact on your credit score more manageable.
If they’ve already sent it to a collection company, don’t panic! You can also negotiate a payment plan with the debt collector and start the process of improving your score.
4. Your credit report has bankruptcies or other negative public records
When a lender sees bankruptcies, collection accounts, and negative public records on your credit report, it may be a red flag if they don’t know the full story. These marks could be due to job loss, illness, or other personal or professional setbacks.
Don’t try to hide these items from a lender when you’re applying for a loan. Be honest about what caused the negative marks and accurately explain the situation. Your lender may be willing to make exceptions based on your situation, especially if your recent record shows you’re managing your credit responsibly.
A bankruptcy won’t necessarily disqualify you from getting a business loan, but if you’ve experienced financial issues related to government programs, you may have fewer options. For example, if you have a financial loss/charge-off to a federal entity related to an FHA first-time homeowners mortgage (or another federally backed mortgage) or your federal student loans, you won’t be able to apply for certain SBA business loan programs.
5. You took on personal debt to pay for business expenses
If you took out a personal loan to get your business off the ground, you’re not alone. Many business owners do this at the start but maybe haven’t considered the impact it will have in the long term.
Consider how you’ll pay back a personal loan while staying on top of your business expenses. Set up a payment schedule that outlines payments from the business to you, and include it as part of the overall budget for your business. This will ensure that you’re able to make your monthly payment on the personal loan while also covering your regular business needs.
6. You have multiple credit pulls happening all at once
Whenever a bank or lender does a hard pull for your credit report, it can lower your personal credit score. If there are multiple pulls in a short amount of time, that will have a greater impact on your score. When you’re evaluating your business loan options, make sure you’re not going so far in the process with each lender that they’re all doing hard pulls on your credit at the same time.
Hard pulls happen whenever a bank or creditor does a credit inquiry on you and your business. When you check your own credit score, it’s called a soft pull. A hard pull will reduce your score, while a soft pull will have no impact on it.
Before you apply for a loan, get a copy of your credit report through a soft pull and submit it as part of your application. Lenders can use this report as part of their prescreening process and will be able to let you know whether you qualify for a loan before they make a hard pull.
7. There are errors on your credit report due to fraud or identity theft
Identify theft and credit fraud have become major concerns for individuals and businesses alike. If you’re proactively monitoring your credit, you’ll be able to catch any fraud or identify theft quickly and clear the errors as soon as possible.
You can also take steps to protect yourself before any fraudulent activity can happen. Take advantage of free fraud alert services offered by the three major credit reporting agencies (Experian, Equifax, Transunion). These services will notify you when they see suspicious activity or if someone is trying to access your credit records without your permission.
You can also place a freeze on your credit with each of the reporting agencies so that only you can access your credit report. Just remember that if you’re applying for credit or a small business loan, you’ll need to reach out to all three agencies to unfreeze your report beforehand. If you don’t, it can cause delays in the application process, or your application could be denied.
Talk to Pursuit about your funding options
If your credit score is low now, don’t give up! Take the steps outlined above to start improving your score today. You can even reach out to lenders now to find out more about their qualification criteria to make sure you’ll meet it when you’re ready to apply.
As a small business lender, Pursuit helps small businesses of all shapes and sizes get the funding they need to reach higher. When you apply with Pursuit, you’ll work with a lender that’s 100% dedicated to your success. We look beyond the numbers to understand your story and how a loan might position you and your business for the future. We offer more than 15 different loan programs, so you have more options to find the perfect fit for your business. Contact us today to learn more about how we can work together.