Many small business owners have misconceptions about how their credit scores impact their chances of qualifying for a business loan. The truth is that lenders use the score as a metric to gauge your ability to repay the loan on time.
Each year, a chunk of business loan applications gets declined due to a poor credit history. However, there is no magic credit score for a small business that guarantees your loan application will get approved.
Why Credit Scores Matter for Business Loans?
A business credit score evaluates the creditworthiness of a business and the financial risk involved in working with your company. The numerical value is calculated by a third-party credit bureau, and lenders use it to determine the financial status of the business. In all, it is a representation of your business’s creditworthiness.
A good score not only provides the business with credibility but also gives it a competitive advantage. If you are comparing a business loan vs a line of credit, know that a poor credit score affects your chances of getting approved for both options.
Each bureau has its own scoring models for calculating credit scores, and the scale of measurement varies. The calculation is based on multiple factors, and the single most important factor is your payment history. So, issues like late payments, charge-offs, repossessions, and liens will hurt the credit score.
Other factors that are considered include existing credit obligations, the time you have been in business, and business type. If your business has a higher-than-average revenue and owns considerable assets, the score is positively affected.
A common question is – are business loans based on personal credit? In fact, many small business owners get confused about business credit vs personal credit. While both scores are unrelated, most lenders will check your personal credit score before approving your business loan. Your ability to manage your personal finances is another metric to evaluate your financial character.
Having a high credit score will increase your chances of getting the best terms and interest rates. A higher score indicates a business with better financial stability and improves its reputation among lenders. It also gives you the power to access a wider range of financing solutions and negotiate for better terms.
Typical Credit Score Requirements by Loan Type
There is no industry-wide credit score standard for the approval of small business loans. If your business is new and business credit has not been established, lenders are likely to check your FICO score. From the perspective of a traditional lender, a personal credit score of 670 or higher is good enough to be eligible for a loan.
For business credit scores, a lender can consider the score from any of the three main business credit-scoring bureaus – D&B, Equifax, and Experian. There are further sub-categories in the scores that the bureaus provide. For example, Equifax provides three different scores in the form of Payment Index, Business Credit Risk Score, and Business Failure Score.
Lenders have varying score requirements based on their policies and risk tolerance. Traditional banks usually require a credit risk score of 680 or higher for business loans. The D&B Paydex score and the Experian business credit scores are measured on a scale of 1 to 100. Generally, scores above 75-80 indicate low risk.
Beyond that, the FICO Small Business Scoring Service is used to judge the creditworthiness of a small business applying for an SBA 7(a) loan. The FICO SBSS score ranges from 0 to 300, and the higher the score, the better it is. For SBA small loans, the current minimum requirement for prescreening of loan applications above $350,000 is 165.
On the other hand, online lenders and nonprofits like Energize Colorado have a different approach for supporting small businesses. Energize Colorado focuses on providing easy funding access to small businesses and supports them through tailored financing programs. We look beyond the standard evaluation of credit scores and consider the business’s ability to have a positive impact on the community.
Factors That Impact Approval Beyond Credit Score
Admittedly, it is unlikely for a new business to have a robust credit score. However, lenders will consider a well-established small business with a longer operating period more favorably. In truth, around 18% of small businesses fail within the first year. So, a business with more longevity is more reliable.
Another factor that is considered is the public record information about a business. If a business has past records of bankruptcy, has been sued, or a judgment has been filed against it, lenders can consider it as negative information. Such information will affect your overall business credit score as well.
A traditional lender, like a bank, can check your bank statements to gauge your financial status. They are likely to focus on the debt-to-income ratio to study the pre-tax earnings of your business. Having an existing relationship with the bank may improve your chances.
Lenders also consider the new lines of credit that a business has applied for in the past few months. Frequent loan applications can indicate a desperation for funds, which can translate to financial instability. As a small business, you need to carefully consider each business credit application.
How to Get a Business Loan with Bad or Fair Credit
Even if a business’s credit score is below the required threshold, not all lenders reject the loan application outright. It undergoes a manual approval process where other factors are taken into account.
For a small business with poor credit, a good idea is to approach a small bank where a loan manager is more likely to meet you in person. A direct interaction makes it easier to present your case. If you want an SBA loan even with bad credit, the best option is to opt for an SBA microloan.
Seeking support from local credit unions and online lenders is a good idea, as they offer more flexibility and have lower requirements for collateral. Research the small business financing options to find out the ones that give you the best odds for loan approval.
As a small business owner, one of the most powerful tools that you have for convincing a lender is a comprehensive and well-thought-out business plan. When lenders realize that you have planned a clear forward path after a thorough market study, they are likely to be impressed. If you find the writing assignment to be challenging, seek help from professionals.
Lenders may be willing to collaborate if you can offer collateral. You can use assets like equipment, real estate, or vehicles to secure a loan. Another option is to apply with a co-signer who has stronger credit. This person can be a business partner, investor, or family member.
It’s important to understand that there’s no guarantee when seeking funding no matter what. You can have good credit, bad credit, collateral, a business plan, no business plan, etc; it’s all subjective. That said, if you have poor credit, there is a higher chance you won’t receive funding because it signals other issues with your personal finances.
Final Thoughts
While a higher credit score boosts the chances of a business loan approval, a poor score does not mean that your business dreams will come to a standstill. Over the past years, Energize Colorado has strived to nurture Colorado’s entrepreneurial ecosystem, offering assistance to small businesses at every stage of their journey. We aim to transform the concepts of small business loans in Colorado through innovation and strategic advising.
Contact us today to find out how our extensive resources can assist your business growth plan.
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