Bad credit history may mean that borrowing money for your business can be expensive. A bad credit business loan often results in higher interest rate payments and additional fees. However, there are steps business owners can take to minimize the impact poor credit history and a low credit score.
Traditional banks and financial institutions rely upon information on loan applications from borrowers that reflect creditworthiness and often use FICO scores from credit bureaus to determine interest rates and loan amounts.
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Borrowers with low credit scores or poor credit histories should not let some of these factors discourage them or feel that they will be shut out of financing options or loan offers. On the contrary, there are many loan options available to small business owners from a variety of business lenders.
The U.S. Small Business Administration (SBA Loan program) is often seen as a viable source for business funding. While we do encourage exploring the SBA, it’s important to understand that the SBA has some of the most stringent qualification requirements for business loans. Generally speaking, the SBA is not the ideal source for a bad credit business loan.
What Borrowers with Bad Credit Need to Know?
Like it or not, many startups; and even established businesses encounter severe financial challenges at some point. It’s almost a rite of passage as business owners strive to achieve profitability. The first thing to keep in mind as a small business owner is that a large portion of businesses experience financial hardship at some point, so know that you are not alone. The second thing to remember is that there are many loan options for small business owners with bad credit.
Depending on your immediate financing needs, there are a few things to consider before you submit a loan application that may help you meet eligibility requirements.
Improving Your Credit
In many cases, your business loan application will be based on your personal credit score. Business credit scores are rarely used to determine credit worthiness for small businesses or startups. So, it’s important to understand how to make the most of your personal credit score before you apply. Some traditional lenders, as well as online lenders, will have a minimum credit score requirement. Credit score requirements will vary from lender to lender. As a rule of thumb, good credit is a credit score of about 650-660. A bad credit score is generally below 550.
There are several factors that make up your credit profile. Most important is your credit score or FICO score. FICO stands for Fair Isaac Corporation, the creator of the FICO Score.
FICO Scores and other credit scores exist to predict risk and the likelihood of paying your bills on time. According to the credit bureau Equifax, a FICO Score is comprised of five categories, each weighted differently as follows:
- payment history (35%),
- amounts owed (30%),
- length of credit history (15%),
- new credit accounts (10%) and,
- types of credit used (10%).
So, what can you do immediately to improve your credit score?
- Get a copy of your credit report
- Check for inaccuracies and outdated items – Dispute any items that you feel are not accurate or outdated. By law, items in your credit file can expire and must be removed. Things like late payments stay on your credit report for up to seven years.
- Negotiate with lenders
- If you have late (delinquent) payments history, you can try to negotiate with your lender. Offering to bring balances up-to-date for example in return for removing late payment notices is another way to improve your score. If the lender agrees, get it in writing.
- Pay your current debts on-time
- Keeping current with your payments over time will reduce the impact of a few (older) late payments.
- Write a “good-will letter to your potential lender
- It’s no guarantee, but writing a letter to a lender explaining the circumstances of late payment and owning the responsibility has been known to help overcome a poor credit score in certain instances.
- When possible, reduce the amount of credit you use
- A big part of your credit score is how much available credit you use. Even paying down one loan or credit card can reduce your credit usage and contribute towards good credit.
- Get a co-signer with good credit
- if possible, get someone with good credit to co-sign your loan application. This could save thousands in finance costs.
Best Bad Credit Loan Types
Once you have taken steps to improve your credit, it’s time to understand different loan types. The first thing most lenders will require is that your business have a bank account. Make sure you have a business bank account (usually a business checking account) and not a personal account, no matter what type of company you set up. Use your business bank account for only transactions related to your business and keep your personal banking separate.
Small Business Loans
Lenders routinely make many types of loans to small business owners, even business owners with poor credit. While the application process is similar across loan types, loan eligibility can vary.
For example, equipment financing is one type of business financing that may put low or no emphasis on your credit score and may involve no credit check for qualifying. Equipment financing is a way acquire necessary equipment for your business.
Lenders will generally use the equipment as collateral in case of payment default and so they may require lighter requirement for loan approval. However, the finance company underwriting the equipment loan may require a personal guarantee. In addition, business owners may be required to submit a business plan to show how the equipment will increase cash flow and contribute to helping pay-off the loan.
Merchant Cash Advance
A merchant cash advance (also known as an MCA) is generally a short-term loan based on a business’s credit card sales, annual revenue and cash flow. An MCA is similar to invoice factoring (or invoice financing) and usually carries a very high interest rate and very stringent repayment terms.
For companies that conduct a lot of credit card sales, an MCA is one of the easiest types of business financing to get. But it’s worth reiterating that MCA’s almost always carry an extremely high rate of interest and should be seen as a means of last resort.
Technically, an MCA is not a loan, it’s a type of business funding where a business owner “sells” a portion of future credit card sales for a lump sum payment.
Business Credit Cards
A business credit card may provide a small, short-term fix for working capital. Traditional banks and credit unions will generally offer a business credit card to members and account holders, even with less-than-good credit.
However, if you have poor credit, you can expect to have a fairly low credit limit to start if you qualify. That said, use your business credit card to help improve your credit. If you are disciplined in your use of a business credit card, it could help to build your credit score.
When using a new credit card, try to limit your credit usage to under 50% of the credit limit and pay-off your balances quickly, making more than the minimum payment each month. After six months of low credit usage and prompt payments, you can request an increase in the amount of money of your credit limit.
Business Line of Credit
A business line of credit is similar to a business credit card in some ways. Only, it’s ready cash instead of credit to make purchases. Also, a business line of credit will generally offer a lower interest rate than a business credit card.
It’s best to first talk to your business banker or credit union representative first to see if they can offer a business line of credit.
Alternative Providers and Business Lenders
If you cannot get working capital loans through the conventional means above, there is a very active “alternative lending” marketplace online. Many online lenders started out as business lenders of last resort, making loans with higher annual percentage rate and origination fees. However, this marketplace has become very competitive in recent years and now often provides competitive rates for borrowers with poor credit.
In particular, online lenders often provide micro-loans for small businesses, but also routinely provide business loans up to $5 million.
Some FAQs and things to remember when seeking business financing include:
- limiting the number of credit inquiries on your credit report. Before submitting an application, most reputable lenders will give you a credit decision without making an official credit inquiry on your credit report. Each inquiry on your report will lower your credit score.
- Carefully read and understand your credit agreement and associated fees and costs. Whether you take a personal loan or business loan, be sure you know the cost of money before you sign an agreement.