Managing Your Credit to Get a Business Loan
March 30, 2017
I’ve worked in business lending for about 12 years and one of the biggest challenges I’ve always encountered when trying to help business owners get a business loan is their personal credit.
Unfortunately, not everyone has good or even decent credit, and it makes it very challenging for banks and other lending institutions to lend without seeing a good payment track history.
About 90 percent of lending decisions in the U.S. are made using FICO Scores and Credit Reports from three different credit bureaus: Experian, Equifax, and Transunion. These three organizations track our credit behavior and receive information from lenders across the nation on our payment trends and credit history and report it back to lenders when someone is looking for a loan.
FICO is an algorithm created by Fair, Issac and Company about 25 years ago that predicts whether or not you’re going to pay a loan back. It’s a very complicated algorithm and nobody really knows exactly how it works, but many specialists have studied it in detail and determined that basic things can either increase or decrease your FICO score.
One thing you could immediately do to improve your FICO score is lowering your utilization ratio; in other words, start paying down some of your credit cards. Utilization ratio is basically how much revolving credit you are using at any given time compared to your available credit. Revolving status is given to credit instruments like credit cards that don’t have a fixed payment and that fluctuate all the time.
So, if you have a $10,000 credit card and you currently owe $3,000 then you’re using 30 percent of the available credit, hence a 30 percent utilization ratio. Experts suggest that you should not have a utilization rate of more than 30 percent and some even suggest you should stay at 10 percent, but I think that’s too conservative. Car loans, mortgages, home equity lines of credit and student loans are not considered revolving.
Experts also suggest for you to have a good mix of accounts to improve your credit. It is recommended to have one or two installment loans like a car, home or student loan, and two or three credit cards. Avoid having department store credit cards as these come with high interest rates.
Needless to say it is also very important to pay your bills on time. Not paying a bill for 30 days can dramatically reduce your score between 60-110 points. You’d be surprised how much this affects your credit score moving forward if you were over 30 days late on something. And the reason is because FICO analyses your payment history for the last 24 months and the most recent, the more it will hurt you.
FICO also analyses the length of your credit history. That is why you should never close an old account because this particular account might be helping your score. The older the account is, the more history they have on you to determine whether or not you are responsible and can pay the Lender back.
Another important factor to consider is the times that Lenders check your credit. Whenever a Bank or Lender pulls your credit it’s considered a hard inquiry and this can lower your FICO score by a few points. The more they check your credit, the more it will hurt your FICO score. However, FICO determines that if a lot of Lenders check your credit in a period of a few days (like buying a car or home) they can consider this to be a shopping period and will only affect your score once. If you decide to check your credit on your own it is considered a soft pull and it doesn’t hurt your credit.
In summary, 30 percent of your FICO score is determined by the amount you owe on your cards (utilization ratio), 35 percent on your payment history in the last 24 months (payments on time, late etc.), 10 percent on the types of credit accounts you have (a good mix), 10 percent on new credit (inquiries) and 15 percent on how long you’ve had a credit history with the Bureaus (length of cards and loans).
But there is light at the end of the tunnel if you have bad credit. A recent law gives you the right to pull your credit for free on an annual basis. You can get one at: www.annualcreditreport.com. Also, check with the SBA for Alternative Business Lenders in the area if you are not able to get a loan with a traditional bank. There are many programs and resources out there for small businesses owners with not-so-perfect credit.