Every business needs funding, and you may need to turn to loans to help fund your business at one time or another. Unfortunately, you may not have the sterling credit required to receive a loan from a bank with favorable terms and low interest rates. If your business doesn’t qualify for a bank loan, where else can you turn?
There is an entire industry of alternative lenders that aim to fill the gaps where banks are unwilling or unable to lend. However, accepting money from alternative lenders requires you to be savvy, or you could dig yourself deep into debt.
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Best business loans for bad credit
Before we get into what lenders look for when approving borrowers and the terms you should expect, here’s a look at our choices for the best business loans for those with challenged credit.
There’s a reason we selected Balboa Capital as the best company for an easy approval: It is willing to look at more than your credit score when underwriting loans. These other considerations include the amount of years you’ve owned the business and its annual sales. With loans ranging from $5,000 to $250,000, this lender can meet many small business owners’ needs. We found in our review of Balboa Capital that it doesn’t require collateral, and the company offers a variety of loan types and repayment terms to choose from.
Building or perhaps rebuilding your credit takes time, and if time is not on your side, consider reaching out to Rapid Finance, our best pick for fast funding. You only need a credit score of 500 to apply for money with this lender. Rapid Finance offers a variety of loan types and funding between $5,000 and $10 million. Loans are typically funded the same day of their approval. When reviewing Rapid Finance, we found that it doesn’t require a lot of paperwork to apply, which makes the process even quicker.
This lender is committed to working with its borrowers long after it approves the loan, which is why Noble Funding is our choice for the best lender for customer service. Part of that is due to its willingness to work with borrowers with challenged credit. For a short-term loan approval, you only need a credit score of 500. In our review of Noble Funding, we found it is willing to look at other criteria when approving a loan. It doesn’t require any collateral or even, in some cases, a personal guarantee.
SBG Funding makes it easy to prove your ability to pay back your business loan. To qualify for one of its loans, you only need a credit score of 500 and to be in business for a minimum of six months. This lender doesn’t require reams of paperwork, nor does it make you offer up collateral. In our full review of SBG Funding, we found that it offers flexible terms between six months and five years, and provides same-day funding – making it our best pick for flexible terms.
Did you know? There are several small business lenders willing to work with borrowers with challenged credit. All of our picks have strong reputations in the market and don’t tack on hidden fees.
What do lenders look for when considering a business loan?
When your business requires funding, your first stop may be the bank or some other conventional lender like a credit union. These financial institutions offer a variety of financial products, including term loans and SBA 7(a) loans.
What does it take to qualify for a loan from a conventional lender? Typically, these financial institutions look at several things.
- Credit score: For your business, there are two types of credit scores that matter – your business credit report and your FICO credit score.
- A business credit score – which is tied to your employer identification number (EIN) – can be registered with Equifax, Experian, or Dun & Bradstreet. Each organization has its own method of calculating business credit scores. For example, Experian considers factors like credit utilization, the size of your business, time in business, public records, and the owner’s personal credit score to calculate a score from 1 to 100.
- A FICO score is your personal credit score, which ranges from 300 to 850. The FICO credit score is tied to your Social Security number and calculated by three credit reporting bureaus: Equifax, Experian and TransUnion. A FICO credit score is calculated using several factors, including debt repayment history, outstanding debts, length of credit history, and whether you have any new lines of credit open.
Tip: Before applying for a loan, review your credit reports from TransUnion, Equifax and Experian to spot any errors that could negatively impact your score. If you find any, contact the companies to get it fixed.
- Debt-to-income ratio: Your debt-to-income ratio is a percentage that expresses how significant your required debt service payments will be in comparison to the money you bring in. For example, if you owe $30 and your income is $100, your debt-to-income ratio is 30%. Generally, lenders look for a debt-to-income ratio in the mid-to-low 30s, though if your company has a debt-to-income ratio up to 43%, it may still be approved for a small business loan.
- Cash reserves: At a bare minimum, lenders want to see that your business maintains several months’ worth of expenses in cash reserves. Depending on the lender, they might expect three months of cash reserves on hand, while others prefer six months or more. Cash reserves assure the lender that even if unexpected expenses arise or sales slow down, your business can still cover loan repayments.
- Collateral: Lenders will also consider the assets your business holds as collateral to back the loan in the event you don’t have money available to make your payments. Common assets include equipment or machinery, land, and real estate.
As part of your loan application, you will likely have to provide several months’ worth of bank statements so lenders can understand your business’s cash flow. However, few elements are as important to a conventional lender as a business’s credit score and the personal credit score of the owner.
What is the credit spectrum?
Lenders look out upon the vast sea of potential borrowers and see a credit spectrum that ranges from very bad to very good. Depending on your business’s position in the credit spectrum, certain types of funding might be unavailable to you. If your business has great credit, you can usually obtain long-term loans with low interest rates; however, if your company is less creditworthy, you might have to pursue more expensive and risky funding options.
“On the one [end] of the credit spectrum is someone who can walk into a major bank and borrow money on the business’s credit, not a personal guarantee,” said James Cassel, co-founder and chairman of Cassel Salpeter & Co.
Those borrowers can expect low interest rates ranging from 2% to 5% on a term loan. Of course, Cassel said, that’s only true for “stellar businesses with great history. On the other side of the rainbow are businesses that can’t get money from any kind of institutional lender.”
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Just as there is a broad range your credit score could fall under, there is a spectrum of financial products to consider. Some – like bank loans or SBA 7(a) loans – are available if you’re a creditworthy borrower, but if you have only decent credit, you might seek a guaranteed loan.
What types of business loans can you get with bad credit?
If your credit history isn’t good enough to obtain a loan from a conventional lender, there are other types of financing – often provided by alternative lenders or private lenders. While the flexibility and speed with which these loans can be approved are useful if you have bad credit, the terms can also be restrictive and the loans expensive.
“The further down you are in the credit funnel, the worse the rates are,” Cassel said. “With great credit, it could be 5%; with bad credit … it could be the equivalent of 40%.”
Should your current credit score fall within the fair or poor ranges, these are some of the most common loans available:
- Short-term loans: Short-term loans include term loans that are repaid in three years or less and lines of credit repaid within one year. If you have good credit, you would ideally leverage short-term loans because of their low cost and easy approval process. Should your company have credit issues, short-term loans can be useful, because lenders often prioritize cash flow over credit score. So long as you have enough revenue and reserves to support a short-term loan, a lender will likely approve your application.
- Hard money loans: Hard money loans include several types of loans that are backed by a collateral asset rather than a credit score. Most often, the assets used as collateral are real estate, such as a building or plot of land. A bridge loan, for example, is a type of hard money loan that is often used for redeveloping a property. The loan is secured by the value of the real estate upon completion of the project, allowing the lender to foreclose on the property if you default on the loan.
- Invoice financing: Factoring – or invoice financing – isn’t truly a loan. Rather, you essentially sell your accounts receivable to a factor at a reduced rate (typically 70% to 90% of the total value). Once the outstanding invoices have been sold, a factor typically begins collecting the payments owed directly from your customers. Invoice factoring can be useful if your business is seasonal or when you need growth capital. However, using this option to cover operational expenses is a risky maneuver.
- Merchant cash advance: A merchant cash advance is also not technically a loan. Instead, it is a form of financing that is backed by credit card sales (or sometimes just revenue in general). Based on your sales volume, a lender will offer a lump-sum payment in exchange for a portion of each of your credit card sales until you’ve repaid the loan (plus fees). Merchant cash advances can be very expensive and are considered a financing option of last resort.
- Microloan: According to the Small Business Administration (SBA), microloans could provide your small business with a loan up to $50,000 in value. The SBA provides these loans to be administered through nonprofit lending organizations. Microloans can be used for inventory, working capital, new furniture or building fixtures, and equipment purchasing or leasing. The average small business takes out approximately $13,000 through a microloan. Each lender has its own criteria for what credit score you would need to get approved.
- Business credit cards: Business credit cards provide another option if your company needs to improve its cash flow. You would often be approved for a business credit card even if you have less-than-stellar credit. However, annual percentage rates may be higher with lower credit scores. The good news is making regular payments will help you improve your credit score.
- Equipment financing: When you enroll in an equipment financing program, you are borrowing funds to purchase or lease equipment needed to run your business. Equipment financing loans provide a payment schedule over a fixed term. Lenders typically provide fixed interest rates for equipment financing. Credit requirements are less stringent because the lender may be able to repossess any equipment if the loan is not paid off.
Before accepting any type of funding, do your homework. Research the lender thoroughly to ensure they are a reputable brand and not a predatory lender. Closely review any repayment terms before signing; have your attorney and accountant review them too, if possible. Only accept money that you can realistically pay back in the specified time; otherwise, further financing could expedite the demise of your business.
Bottom line: Several loan types are available to borrowers with bad credit. Before accepting a loan, make sure you can afford to pay it back. The last thing you want is to default on the loan so the lender can come after your collateral.
Factors to consider before applying for a business loan
Business loans can cover any costs necessary to run your company efficiently. You can take out loans to pay for building space, equipment, inventory, building upgrades and more. Lenders will likely ask to review your business plan as part of the application process. Compare multiple business lending options and financial institutions before submitting an application for a loan.
Here are a few items to look out for before choosing a lender for a small business loan.
Type of lender
Various types of lenders fund small business loans. Traditional lenders are banks and credit unions that provide standard loan options. This route is usually preferable if you have good credit, since the terms and annual percentage rates are usually more favorable than those of alternative lenders. A traditional lender will have strict criteria that determine whether you’ll be approved by a loan and how much money you receive.
Alternative lenders have grown in popularity and can be a good option if you have poor credit or nonexistent credit history. Two examples of alternative lenders are business credit card providers and microloans. Another alternative lending option is private loans or marketplace lending platforms. Depending on the terms, an alternative funding source may work for your company.
Years in business
As part of reviewing your loan application, lenders want to know about your experience. If you have been running an established business for more than five years, your lending potential is greater. Lenders also consider your industry experience. For instance, FSA farm loans from the U.S. Department of Agriculture are given to farmers who have a proven background in owning or running a farm.
Reviewing the loan terms is critical to gain a financial advantage in your industry. Even if you have bad credit, you don’t want to fall into debt without any hope of earning a profit. The lender should be able to provide the amount of money you need and release funds quickly. Loan rates should be favorable, with payments falling within your budget. First, review any loan restrictions that the lender may have in place. Next, determine if the lender will ask for any form of collateral before approving you for the business loan.
How to qualify for a short-term loan with bad credit
Short-term loans are a type of small business loan that closely resembles a conventional term loan in many ways. Short-term loans carry an interest rate and require repayment of both principal and interest within a certain period, just like a bank loan. However, because the term is less than a year, short-term lenders are more concerned with your company’s cash flow than its credit score.
“Banks ask for all types of collateral, and personal credit is very important to the bank,” said Michael Baynes, co-founder and CEO of Clarify Capital. “What’s important to us is cash flow [demonstrated] through six months of bank statements. If we feel [a business’s] bank balance can support our funding over the next four to 12 months, we’re comfortable lending to them, regardless of personal credit score.”
1. Don’t be overleveraged.
Generally, Baynes said, alternative loans require a one-page application, along with a minimum of three months of bank statements. That’s all an alternative lender needs to approve or deny your loan application. But what exactly are alternative lenders looking for?
“The most common reason we reject an application is due to a business being overleveraged,” Baynes said. “If they already have existing debt … and we feel additional payment would overleverage them, we would turn the business down. The other reason an application would be declined would be low revenue and low daily bank balances. We need to see $10,000 to $15,000 per month in revenue or deposits. If they struggle with overdrafts or negative days in their bank account, we’re not confident they can make the payments.”
2. For fast funding, maintain your financials.
The approval process for these types of alternative loans tends to be much faster than conventional banks, which could take weeks or months to approve your loan application. If approved, funding for alternative loans can often be delivered within a few days at most.
To expedite approval, it’s important to maintain good financial documentation. According to Cassel, keeping detailed, accurate books is one of the most important things your business can do.
“Make sure your financial house is in order,” he said. “Every business needs to have monthly financials. They need to be available no later than 10 to 15 days after the end of the month. Some businesses don’t get them until 90 days after the month. Then you’re 90 days further in the hole, and it’s too late to correct it.”
Good books not only help you avoid financial trouble, but also give lenders the insight they need to make a decision on whether to extend financing to your organization.
Tip: To streamline the process of obtaining a small business loan, make sure all your paperwork is accessible. That includes bank statements, sales and profit statements for your business, and monthly financials.
How can you begin repairing bad credit?
There are advantages to repairing a damaged credit score even if you do qualify for funding. As Baynes said, an improved credit score can avail your business to better terms and rates. While rebuilding credit can be a long and arduous process, you should do it when your financial situation has stabilized.
1. Keep up with personal payments.
“Obviously, first and foremost is staying current on your personal credit payments,” Baynes said. “These are things like auto loans and credit cards. Maxed-out credit cards drive down your credit score. Missing payments, or just making minimum payments, brings down your credit score tremendously.”
2. Make a detailed plan for credit rehabilitation.
According to Cassel, business credit rehabilitation can be extremely difficult and requires a detailed plan. While maintaining your personal credit score, you also need to keep an eye on your business’s debt service.
“When businesses get into trouble, they should put together a 13-week cash flow [projection] of expected funds in and expected funds out,” he said. “This helps them manage cash and decide what to pay for.”
3. Seek ways to pay off debt.
There are some ways you can seek relief to stabilize your company’s financial situation, such as raising prices. You may be reluctant to raise prices, Cassel said, because you are afraid of losing customers. In many cases, though, there is more room to hike rates than you realize.
You could also ask suppliers to extend payment schedules. If you are a good customer who has kept up with payments in the past, a vendor is likely to work with you; after all, they don’t want to lose you as a customer.
4. Don’t despair.
If you’ve partnered with a certain lender before, they might be willing to lend a bit more to your business if they see you are on the road to financial rehabilitation. This is known as an “airball,” Cassel said.
If things become truly dire, you can usually call in a restructuring firm to reorganize operations.
“Sometimes it is a vicious cycle that is impossible to get out of,” Cassel added. “As things get worse, the cost of borrowing goes up, so you have to figure out how to stabilize the business. Once you stabilize, you can focus on repair.”
Unfortunately, when financial troubles become pervasive enough, you must reckon with the hard truth: The best option, Cassel said, is sometimes to cut your losses and stop the bleeding.
“You’ve got to look at the viability of the business,” he said. “Business owners have to be honest with themselves about long-term viability.”
5. Be realistic about borrowing.
Ultimately, securing financing should be a way to get your business to a better place on the credit spectrum. That way, the next time you need funding, you can successfully pursue a financial product with better rates and more favorable terms. If financing doesn’t support that type of progress, then it could just be digging your business into a deeper hole.
Cassel had this advice for struggling businesses: “Be honest, try to get a loan, and, ultimately, get back to a better lender. Some businesses never do, and owners start to feel like they’re working for the bank.”
Financing can be a great tool, but taken irresponsibly or out of desperation, expensive loans can be the death knell for your business. Always have a plan for any money you borrow, and keep an open line of communication with your lenders. If you do, you could be well on the road to credit repair.
Adam Uzialko contributed to the writing and reporting in this article. Some source interviews were conducted for previous versions of this article.