The Importance of Personal Credit for Small Business Owners

As a small business owner, maintaining a good personal credit score is crucial, even though your business might be the one seeking financing. Lenders often look at your personal credit history as a key factor in determining the financial health and reliability of your business. This is especially true for early-stage businesses (less than a year old) that haven’t yet established a strong credit profile of their own.

Your Personal Credit Score and How It Affects Your Business

In the early stages, your personal credit score plays a significant role in the approval process for small business loans. Since a new business may not yet have a track record or established business credit, lenders often rely on the personal financial history of the business owner. While many believe personal credit doesn’t accurately reflect a business’s ability to pay its debts, most traditional lenders continue to use it as a key indicator of trustworthiness.

A personal credit score offers insight into how a business owner manages their finances, including paying bills, credit utilization, and overall debt management. When evaluating your eligibility for a loan, lenders will take this into account.

Understanding Your Personal Credit Score

The FICO Score, introduced in 1989, is the most widely used formula for determining an individual’s creditworthiness. It ranges from 300 to 850 and is used by most financial institutions, including lenders for small business loans. The score is calculated based on data collected by the three major credit bureaus: Experian, TransUnion, and Equifax.

Here’s a breakdown of the FICO Score calculation:

• 35% Payment History: Late payments, defaults, bankruptcies, and other negative marks lower your score.

• 30% Amounts Owed: This includes your debt-to-credit ratio and the number of accounts with outstanding balances.

• 15% Length of Credit History: Longer credit histories are seen as more reliable indicators of future financial behavior.

• 10% Type of Credit Used: Demonstrating responsible use of different types of credit (credit cards, mortgages, installment loans) is beneficial.

• 10% New Credit: Applying for multiple new lines of credit within a short time frame can negatively impact your score.

What’s Included in a Credit Report and How It Affects Your Score?

Your credit report details your personal financial behavior, including credit accounts, loan balances, payment history, and any negative events like bankruptcies. This report is used by the credit bureaus to generate your FICO Score. A higher score generally means better creditworthiness and increases the likelihood of loan approval at favorable terms.

When a small business lender looks at your personal credit score, they are assessing the likelihood that you will meet financial obligations on behalf of your business. Here’s how lenders might view different credit score ranges:

• Below 579: Bad – Lenders see this as high risk. You might still be able to access some financing, but expect higher interest rates and stricter terms.

• 580-619: Poor – At this level, business owners may struggle to secure traditional loans or receive high-interest offers.

• 620-679: OK – This is considered moderate risk. Business owners may qualify for loans but will likely face higher rates than those with better scores.

• 680-719: Good – This is a solid score, and business owners will have better access to loans with competitive interest rates.

• 720-799: Very Good – A very good score opens doors to loans with favorable terms and low interest rates.

• Above 800: Excellent – A score above 800 is exceptional, and business owners will receive the best possible loan terms and interest rates.

6 Tips to Improve Your Credit Score

Improving your personal credit score is a long-term process, but with focused effort, it can be done. Here are some strategies:

1. Know Your Score: You are entitled to one free credit report each year from the three major credit bureaus. Regularly checking your credit will help you stay informed of any issues or discrepancies.

2. Use Credit Wisely: Avoid maxing out your credit cards. Keeping your balance below 30% of your available credit is recommended. Ideally, aim for no more than 15% usage to improve your score.

3. Avoid Transferring Balances Frequently: Moving debt from one account to another won’t improve your score and may have negative consequences.

4. Make Payments on Time: Payment history accounts for the largest portion of your credit score. Even one late payment can significantly impact your score.

5. Don’t Apply for Credit You Don’t Need: Every time you apply for credit, it results in a hard inquiry, which can lower your score. Avoid applying for new credit unless it’s absolutely necessary.

6. Be Patient: Improving your credit score takes time. A gradual, steady improvement over six months to a year can make a significant difference.

Why Personal Credit Matters for Your Business

Although your business might not have an established credit history, your personal credit is often used as an indicator of how your business will manage its finances. Traditional lenders rely on your personal credit score to assess whether you’re a trustworthy borrower.

Even though the personal credit score does not reflect how your business will meet its obligations, it’s still vital to keep your score in good standing. This is especially true for small business owners who may face challenges securing financing in the early stages of their business.

At Vice Funding, we understand how important your personal credit score is to your business’s success. We offer resources and support to help you navigate financing options that take your credit history and business needs into account.