When looking for a business loan, there are some important differences between personal and business credit. If you aren’t sure or have questions about how one relates to the other, here are explanations about how each works and the importance of credit as it applies to getting a business loan.
How Personal Credit Works
Everyone has a credit file – which is linked to your social security number – with each of the major credit bureaus: TransUnion, Experian, and Equifax. Here, all your credit actions are reported, including negative reports such as missed payments or filing for bankruptcy. Incidents such as these stay on your credit file for up to a decade. Of course, positive credit actions are also recorded such as paying off a credit card or perhaps a loan. When a creditor is considering you for a loan, they will request permission to contact these bureaus for a copy of your credit file, which is also known as a credit report.
Credit scoring is another aspect that lenders will look at before giving you any form of personal credit. The credit score is a 3-digit number which represents your credit file, rating it on a scale between 300 and 850. Lenders have criteria for approval and interest rates based on this number. For example, scores over 700 are considered good so would allow for approval and a low interest rate. Your credit score is available through the main credit bureaus and most lenders use a model called FICO. The Fico Score is based on the following 5 categories:
Length of credit history
For more information, see the myFICO website.
Personal credit capacity, in this context, refers to the maximum amount of financing you can receive from a lender. Your personal credit capacity is something that is built up over a number of years as your report and score improves. For example, when someone first applies for a credit card, because they might have very little credit history to look back on, a lender might only provide a very small credit amount like $500. Over time as you prove your ability to pay off larger and larger amounts and increase your credit score, you will be granted larger loans.
How Business Credit Works
Establishing business credit is different from personal credit in several ways.
Let’s start with the employer identification number. Basically, this is a company version of a social security number. It’s assigned by the Internal Revenue System and is used by companies as a form of identification. This number is used instead of a SSN when creating credit files with various business credit agencies. If you own multiple companies, each one will have a unique employer identification number and a separate credit file.
Business Credit Score
A business credit score measures the creditworthiness of a company. It differs from personal credit scores in a number of ways. Here the FICO business model uses a lower range. Where personal FICO scores are from 300 to 850, the business range is from 0 to 100.
Although personal credit scores and reports can be seen for free once per year, as well as through credit services like QL Credit, a business credit score has to be paid for. All information regarding a company’s credit report is not private and can be seen by anyone who wishes to pay for a report from the credit bureaus such as Equifax and Experian.
Business Credit Capacity
In terms of credit capacity, a business is can be granted between 10 to 100 times more than personal allowances according to Entrepreneur.com. This enables you to raise the funds needed to grow your business. If you own more than one business, your options are increased for credit as each will have its own credit capacity.
How to Build Business Credit
To build your business credit profile, you will want to open up business accounts such as utilities and credit cards with your EIN and pay the bills regularly. You can also purchase equipment or supplies from vendors who send reports to credit agencies. Similar to personal accounts, you will also have to start with smaller loan amounts and pay them on time, before being trusted with larger amounts.
The Role of Credit in Getting a Business Loan
Let’s look at the importance of personal credit for a business loan. Do you need to have good personal credit? Not necessarily, but it certainly does help. However, there are a couple of ways to apply for a loan through which credit history is weighed differently.
Personal Loan for Business
You can apply for a personal loan for your business with your personal credit. If you have a score higher than 640, you may get approved, however anything over 700 increases the likelihood greatly. The downside to this is that by using your personal information, you will not be building business credit and the approval amount will be smaller than a business loan.
Business Loan Based on Personal Credit
If you have a very high personal credit score, close to 800, you can apply for a business loan based on your personal credit, however standards for lending are often stricter because business loans are larger than personal loans. Furthermore, you won’t build your business credit and inquiries for a business loan lower your personal credit score.
Business Loan Based on Business and Personal Credit
You can also apply for a business loan using your business and personal credit. This can be helpful for those who may have poor or recovering personal credit histories. In this case, there will be a few things you need to gather for your application. These include your business details, a business plan, your business credit report, financial statements, and legal documents. These will be considered in addition to your personal credit history.
Deciding which loan is right for you will depend on your particular situation. In order to improve the likelihood of approval, it is best to build both your business and personal credit.
With a good understanding of the differences between personal and business credit, where you stand in terms of both, and how to present your case to a lender, you will be on the path to getting the lending you need to grow your business. Here are some best practices to help you prepare if you are considering applying.