Don’t let your credit score get in the way of your entrepreneurial dreams

Personal credit isn’t the only thing that determines whether you’ll get approved for a small business loan, but don’t let it be the one thing that stops you from pursuing your dream.

Prospective entrepreneurs and established business owners alike will benefit from understanding how their personal credit histories can impact whether they qualify for a loan for their business.

What goes into qualifying for a business loan? Lenders look at capacity, collateral and credit. Let’s look closer at what those terms mean.

Capacity

In this context, capacity is an evaluation of whether you can demonstrate the ability to repay the loan. To determine capacity, lenders look at overall gross income, less itemized expenses, resulting in a net income figure of cash available to make debt payments. This information is typically found in an income statement (also known as a profit and loss statement), and lenders will want to see and compare two to three years of historical data to get an idea of the capacity of a business to pay all debts, as well as to identify trends in the business (for example, increasing income as a business matures and sales grow).

Collateral

Collateral means assets that you have that will back the value of the loan. Examples include real estate, equipment, savings and more. This collateral secures the loan and would be claimed by the lender and sold to repay the loan if the business or guarantors are unable to make the loan payments, reducing the risk to the lender.

Credit

While it is the last component looked at, business and personal credit are still important to consider, especially if you have no credit or your credit history has been impacted by economic events of the past few years.

There are business credit scores. These reflect the historical performance of the business in on-time payment to vendors and suppliers and in meeting overall obligations of the business. Similar to consumer credit reports, these reports include any public records such as judgements, tax liens and bankruptcy that may have been filed by or attached to the business.

Personal credit scores are also used to evaluate the credit worthiness of a loan applicant. These scores are generally graded using a FICO, Vantage or other scoring model. A personal credit score is computed by evaluating several factors. Payment history considers if you have late payments recorded in your credit history, and if so, how many times you were late. Utilization ratio looks at how much available credit you have compared to actual loan balances. A good rule of thumb is to keep your balances below 30% of available credit for any revolving credit lines. Length of credit looks at how long you have had an established credit history. Have you been using credit for three years or three decades? A long history of on-time payments could help your score.

Lenders use credit in part to determine the character of the business owner(s), and just as with consumer borrowing, a strong credit history reflecting on-time payments and all obligations being met can be valuable in qualifying for small business loans.

If you need to review your credit report, you can download a free copy once per year from each of the three credit bureaus on annualcreditreport.com. While you’re reviewing that, be sure to look for inaccuracies to dispute, like accounts you didn’t open, or late payments that you know were made on time.

If you need further help or guidance figuring out how to qualify for your business loan, talk to your lender or the Small Business Administration (SBA).

— Lindsay Hendrix joined the Mountain America Small Business Lending team as an SBA loan officer in August 2022. She is serving small businesses and their lending needs in Western Idaho.