Updated October 8, 2021
A loan can act as a vital financial lifeline for any small business, providing the capital necessary to grow, survive a temporary downturn, and more. Unfortunately, if a business owner has bad credit or no credit, they can feel locked out of traditional lending opportunities. The fact is that you don’t need perfect credit to get a business loan.
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So what is a bad credit small business loan? It sound terrible, but it is not a cause for panic. Traditional banks and traditional lenders use credit scores to determine: loan amounts, repayment terms, personal guarantee, credit limits and sometimes offer better terms on certain loan options or other funding options. This may include minimum credit score requirements as well, but that’s not the whole story.
While it’s true that poor credit typically restricts the ability to get most bank loans and SBA loans, many other lending options are available. Here’s a closer look at how to get a small business loan with bad credit, including the different types of loans available, how to improve the lending terms, and more.
First, the business owner needs to know their credit score. When considering taking a loan, business owners should immediately get a copy of their personal credit report. Knowing your own creditworthiness will help you to understand your financing options, loan amounts and help in filling out a loan application. It is advisable to get a copy of your credit report from all major credit bureaus (Transunion, Experian). These reports often vary as will your FICO score from one to the other. In fact one credit bureau may show that you have good credit and another could show a fair or a poor credit report. Small business owners are strongly advised to review their credit reports for accuracy and timeliness. You have the right to dispute inaccuracies or items that are deemed to have expired. So, for example, Experian may show an old account on your report while TransUnion does not. The bottom line? A poor credit score is not the only factor in getting a loan.
Lenders consider both the business credit score and the owner’s personal credit score (FICO) and credit history. As a general rule, fewer lending opportunities are available once someone’s credit score is below 500 (although options still exist). Credit score requirements and minimum credit score figures are an important part of the loan decision, but they can be overcome by other factors. This is especially true with alternative lenders or online lenders (non-bank institutions).
For existing businesses, factors such as cash flow, payment history, annual revenue, and having a business bank account can overcome bad personal credit for certain types of loan underwriters. If your business loan application shows a positive track record it may be possible to minimize your bad credit score and enhance your eligibility to acquire business funding.
Business owners will need to present a clear, organized business plan. Details help give potential lenders confidence in the growth and success of a business. Monthly sales earnings are often an essential part of a business plan, as the ability to show consistent growth can overcome lender hesitancy over a low credit score.
Additionally, the business owner will need to develop an extensive plan for the money. For instance, if a business owner plans to purchase equipment, they should explain how they’ve made similar upgrades in the past and how it led to an increase in customers and profits.
Finally, business owners with bad credit will need to prepare for higher interest rates. Some owners overestimate their ability to make loan payments on time. Unfortunately, missing even one payment can lower the person’s credit score even further, making their overall credit score even worse.
How to Get a Business Loan with Bad Credit
There are a few different ways someone with poor credit can improve their chances of getting a small business loan.
A borrower who can provide collateral increases their likelihood of obtaining a loan. There are two types of collateral typically available to business owners low on capital. First, invoice financing allows unpaid invoices to act as collateral, with the lender advancing a percentage of each invoice. Also, equipment financing is common, where purchased equipment serves as collateral.
Another way to improve the likelihood of obtaining a loan is by using a co-signer. If the co-signer has a high credit score, a steady source of income, or both, they can help the primary borrower secure more favorable loan terms.
During the entire process, the business owner should diligently strive towards raising their credit score. While it can be a slow process, it’s also the most effective way to access larger loans and lower interest rates.
Types of Bad Credit Business Loans
There are many different online bad credit loans borrowers will want to consider.
Merchant Cash Advance
A merchant cash advance is a type of business financing where the business owner receives a lump sum they can use however they like. However, instead of repaying the money in a traditional way, the lender receives a percentage from every credit card transaction at the business.
MCAs are an alternative to poor credit loans. They’re useful for borrowers with extremely low personal credit scores who quickly need a large sum of cash.
Short-Term Business Line of Credit
A business line of credit functions similarly to a credit card. The borrower accesses funds on an as-needed basis up to a predetermined amount. Interest is only charged on the open balance, so the borrower has a significant amount of control over how much they borrow.
Short-Term Business Loans
A short-term business loan is the most traditional type. It provides a lump sum that the borrower must pay back according to a set schedule. When the borrower has poor credit, the loan works in the same way but typically has higher interest rates.
Collateral loans use specific property to secure the loan. As mentioned above, the two most common types of collateral used by borrowers with bad credit are new equipment and outstanding invoices. These loans are also referred to as secured business loans.
Working Capital Loans
Working capital loans provide funding for the daily operations of a business. They cover employee wages, inventory purchasing, tax payments, and similar financials needed to keep the business running. Note that working capital loans can’t be used to purchase equipment or for long-term needs.
Business owners who learn how to get a small business loan with bad credit create numerous opportunities for security and growth. Borrowers should first determine their credit score, develop a clear plan for the loan, and then carefully consider the pros and cons of each loan option.
A financial setback doesn’t need to result in the permanent closure of a small business. Solutions are available, even if the owner has a low credit score.