For small business owners, building and maintaining strong personal credit scores can be the difference between your company’s success and ruin. It seems counterintuitive that your personal credit score can have such an effect on your small business, but it’s true.
Here are ten things to know about your personal credit score, its effect on your small business, and how you can improve your score to make sure you’re giving your company the best possible chance to succeed.
1. Lenders will always look at your personal credit score when deciding whether to fund your small business.
For small business owners as much as the rest of the population, what a credit score truly does is put a number on how well a person manages his or her finances. Your credit score isn’t the be-all, end-all number that proves whether or not you’re capable of running a business, but it does provide lenders with a simple metric to help decide if they’re likely to see their investment repaid.
Of course there are reasons to separate business and personal credit. But when you’re just getting started, that score is a huge boon. The personal credit score dominance has become less critical as financial technology companies such as Buffalo Business Loans rely more on the business factors and a company’s ability to repay a loan. However, for the foreseeable future a personal credit score is still an important factor.
2. Credit scores indicate how risky it may be to lend you money.
At the end of the day, that’s what that number means. Your score, on a scale of 300-850, gives a quick rating to how likely it is that you’re able to repay your debt on time and in full. That’s it. Lenders provide better terms to less risky borrowers and more stringent terms to riskier ones.
3. There are five factors used to calculate a credit scores.
Do you pay your rent, loans, auto lease, or other payments on time and in full? If so, you’re well on your way already. It’s estimated that payment history is the most important credit score factor.
Total Amount Owed
This factor looks at how much credit you have available to you and how much you’ve used. If you’ve got three credit cards totalling $5,000 as a total limit, your score will be positively affected by having a smaller amount outstanding. The amount of money you’ve used on a line of credit compared to the maximum allowed is called your utilization percentage.
On the other hand, if your cards carry a balance of $0 at all times, it will tell lenders that you don’t spend at all – and your score will be hurt.
Length of Credit History
For lenders, a longer credit history is better. Combined with the two aforementioned factors, a long credit history shows you’re capable of using a line of credit responsibly for an extended period, making you a more desirable borrower.
Types of Credit
Remember, credit scores are, above all else, a way for lenders to quantify your dependability. Showing that you’re capable of managing different types of loans is one way to prove yourself. Are your auto loan and credit cards both paid in full each month, every month, for years? Then you’ve shown yourself to be trustworthy with regards to credit.
A borrower who is constantly opening new lines of credit may appear to be someone who struggles with financial responsibility. Plus, a new line of credit impacts your length of credit history, and will hurt double. The best rule of thumb is to only open new lines of credit when absolutely necessary.
4. You don’t need to spend more money to improve your credit score.
Once you know the ways your credit score is calculated, you can use that knowledge to improve your score even without necessarily spending more money.
You know that amount of credit utilized is a factor in your credit score. If you carry a balance of $500 on a credit card with a $1,000 maximum, try calling your credit card servicer and requesting a credit increase (after all, you’ve been making your payments on time, haven’t you?). $500 on a $1,000 maximum is 50% utilization. But if your lender boosts your maximum to $2,000, you’ve cut your utilization percentage in half without spending a penny.
And in addition to that decrease in utilization percentage, you’ve also freed up the ability to spend more on your business, which can be helpful with cash flow problems, particularly in your business’s infancy.
Alternatively, you may have a credit card sitting around which hasn’t been used in months. Maybe you’re considering closing that account. One simple way to improve your credit score is to leave that account open. The account history ages without affecting your utilization percentage, and that helps your score.
5. Maximizing your credit score helps your small business in lots of ways.
Particularly in the early days of your business’s life, having a high personal credit score will allow you to give your company a real advantage.
Having a good credit score – often defined as a score above 700 – means that you’ll be capable of qualifying for larger bank loans at lower interest rates, business credit cards with higher limits, and will have access to more types of loans and credit. Those lower interest rates mean you’ll be free to use those savings to invest even further into your business.
6. Bad credit scores don’t necessarily mean you’re out of the game.
Even if your score is lower, you may still be able to acquire financing. But always consider the lenders’ perspective. Your lower score indicates that you’re a riskier proposition, and the terms of the loan will reflect that risk.
A small business owner with a higher score might be able to acquire loans that are longer term, with more money, and a lower interest rate. Your lower score will mean that your APR could be as high as 30% or more, and you’ll be required to repay those loans in a much shorter time frame.
7. Good credit can be a cycle, particularly for small business owners.
If you’re thinking of getting a loan or starting a new business, remember that maximizing your personal credit score is a key way to get your business on the right foot. A higher personal credit score means a better financial situation for your business. A better financial situation for your business means faster and higher profits. Higher profits lead to a better personal credit score, and so on.
A personal credit score is an extremely important number for everyone, and particularly for small business owners. Make sure to take the time you need to understand what a score is, how it’s calculated, and where those calculations leave you.
Understanding your credit scores can help you improve it, and that improvement can help set your business up for long term success.