By Mark Abell
Small business owners can significantly improve their chances of getting a loan approved by first taking steps to boost their personal credit score.
The biggest factors that any bank looks at when deciding whether to approve a loan are the 5 Cs of credit: capital, collateral, conditions, cash flow, and creditworthiness. For young companies, consultants operating as solo practitioners, and early-stage startups, that creditworthiness component leans heavily on the owner’s personal credit.
So, trying to keep your personal credit score as high as possible will give the company the best chance that an application for a U.S. Small Business Administration-backed loan will get approved.
To understand your credit score better, you’ll first notice that the FICO scores of the national credit bureaus—Equifax, Experian, and TransUnion—use a different method than banks. For example, Experian uses a FICO 8 score, a different methodology from the FICO 5 score banks use. The FICO 8 scores creditworthiness on a scale ranging between 300 and 850 while the FICO 5 scores from 334 to 818.
FICO 5 scores are weighted 35 percent for payment history, 30 percent for the amount of available credit used, and 15 percent for the length of credit history, with credit mix and new credit applications each weighted at 10 percent. Typically, small business lenders want to see scores above 680 to consider an applicant. However, business owners with borderline credit scores can take some smart steps to boost their score by 50 points or more.
1. Establish a Good Payment History
That starts with allowing loans to “season,” in banker parlance. Bankers like to see loans such as mortgages in place for several years. It’s OK to refinance a mortgage every few years, but doing so every year gives the appearance of using a home as an ATM and hurts a credit score. A fast way to improve a score is to pay bills on the 11th of the month, four days before credit bureaus report outstanding debts. Paying credit card and loan payments on the 11th gives time for those payments to clear before the 15th, meaning that credit scores will reflect both on-time payments and lower credit utilization—a double boost. Making that change could, for example, improve a credit score from 650 to 710.
2. Manage Credit Use Wisely
Banks like to see that more than 70 percent of credit capacity is available. People using 50 percent or more of credit availability are viewed as marginal, while those with 30 percent or less of their available credit are viewed as a poor credit risk. For someone with a credit availability of $10,000, it makes a huge difference whether they carry $7,000 of debt or pay it down to $3,000. That lower balance can often be achieved as easily as paying a credit card statement a few days earlier than usual.
3. Keep Credit Accounts Open
People often make the mistake of paying down a credit card to reduce their debts and then close the account. Paying the card down 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 Matter
When it comes to credit mix, banks prefer secured debt such as mortgages, but having a blend of debts, ranging from a mortgage to a home equity line of credit and credit cards helps.
All of the credit bureaus are required to give consumers one free report annually, so business owners should request a report from one bureau every four months to stay on top of any issues that may arise.
5. Address Any Blemishes
These days, with doctors outsourcing their billing, insurance-related collections are a major source of nuisance on credit reports that can often be fixed with a few phone calls or by making some payments for overlooked, outstanding charges. By checking reports, consumers can also find errors and dispute them.
Consumers often find accounts that were charged off, perhaps when an interest charge accrued after an account was closed. Specialist credit repair lawyers can resolve these errors by writing to creditors requesting evidence of non-payment after an account closure request or removing the report from their bureau report. Such action can clean up a credit score in a few months.
Not all problems can be fixed, but most banks will overlook old medical collections, especially if they stem from a single issue, for example, a bankruptcy dating back more than 10 years ago that no longer shows on bureau reports.
When figuring out how much a small business owner can repay each month, it also matters what type of debt a person carries. For example, for $10,000 of credit card debt, most banks estimate a 5 percent monthly minimum payment, or $500, compared to a home equity line payment of about $46/month, or an unsecured 5-year term loan whose estimated payment would be $212/month.
A recent survey conducted by regional Federal Reserve Banks finds that getting a loan is the No. 1 challenge facing small businesses. That problem is particularly acute for smaller companies with revenues of less than $1 million. Among those firms, 55 percent are turned down for a loan, so improving personal credit scores is vital. And it’s easier than many people think.
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