By Mark Abel
Small business owners can significantly improve their chances of getting a loan approved by first taking steps to increase their personal credit score.
The main factors a bank considers when deciding whether or not to approve a loan are the 5 Cs of credit: principal, collateral, terms, cash flow and creditworthiness. For start-ups, consultants operating as independent practitioners, and early-stage startups, this creditworthiness component relies heavily on the owner’s personal credit.
So, trying to keep your personal credit score as high as possible will give the business the best chance of being approved for a loan application backed by the US Small Business Administration.
To better understand your credit score, you’ll first notice that the FICO scores from the national credit bureaus – Equifax, Experian and TransUnion – use a different method than the banks. For example, Experian uses a FICO 8 score, a different methodology than that used by FICO 5 score banks. FICO 8 scores creditworthiness on a scale ranging from 300 to 850 while FICO 5 scores from 334 to 818.
FICO 5 scores are weighted 35% for payment history, 30% for amount of available credit used, and 15% for length of credit history, with a combination of credit and new credit applications weighted each at 10%. Typically, small business lenders want to see scores above 680 to consider an applicant. However, business owners with borderline credit scores can take smart steps to boost their score by 50 points or more.
1. Establish a good payment history
It starts with allowing loans to “season”, in the language of bankers. Bankers like to see loans such as mortgages that have been in place for several years. It’s okay to refinance a mortgage every few years, but doing it every year feels like using a house as an ATM and hurts your credit score. A quick way to improve a score is to pay the bills on the 11e of the month, four days before the credit bureaus report outstanding debts. Pay credit card and loan payments on the 11the gives time for these payments to clear before the 15the, which means that credit scores will reflect both on-time payments and less credit use, a double boost. Making this change could, for example, improve a credit score from 650 to 710.
2. Manage credit usage wisely
Banks like to see that more than 70% of credit capacity is available. People using 50% or more of available credit are considered marginal, while those with 30% or less of their available credit are considered low credit risk. For someone with a credit availability of $10,000, it makes a huge difference whether they have $7,000 in debt or pay it off at $3,000. This lower balance can often be reached as easily as paying off a credit card statement a few days earlier than usual.
3. Keep credit accounts open
People often make the mistake of paying off a credit card to reduce debt and then closing the account. Paying the card could improve a score by 8 points, but closing the account reduces the amount of available credit, which could reduce a score by 20 points.
4. Types of debt
When it comes to credit mixes, banks prefer secured debt such as mortgages, but it’s helpful to have a combination of debt, ranging from a mortgage to a home equity line of credit and credit cards .
All credit bureaus are required to provide consumers with one free report per year. Business owners should therefore request a report from an office every four months to stay on top of any issues that may arise.
5. Treat blemishes
With doctors outsourcing their billing these days, insurance-related collections are a major source of credit report nuisance that can often be fixed with a few phone calls or by making payments for unpaid and overlooked charges. By checking the reports, consumers can also find errors and dispute them.
Consumers often find accounts that have been charged off, perhaps when interest has accrued after an account has been closed. Credit repair attorneys can resolve these errors by writing to creditors asking for proof of nonpayment after an account closure request or by removing the report from their office report. Such an action can clean up a credit score within months.
Not every problem can be solved, but most banks will overlook old medical collections, especially if they stem from a single problem, for example, a bankruptcy over 10 years old that no longer shows up on the bank’s reports. desk.
To determine how much a small business owner can repay each month, it is also important to know what type of debt a person is carrying. For example, for $10,000 of credit card debt, most banks estimate a minimum monthly payment of 5%, or $500, compared to a home equity payment of about $46/month, or a 5-year unsecured term loan with an estimated payment of $212. /month.
A recent survey by Federal Reserve Regional Banks reveals that getting a loan is the #1 challenge facing small businesses. This problem is particularly acute for small businesses with revenues under $1 million. Of these companies, 55% are denied a loan, so improving personal credit scores is essential. And it’s easier than many people think.
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