No matter how well your business is performing, opportunities come along that require additional capital. Getting the cash to buy equipment, purchase inventory, or add staff often requires taking out a loan. The right business loan could mean the difference between having a good year and a great year.
But what happens if you have bad credit? Are you out of luck? The short answer is no. Here's how to get a business loan with bad credit.
Why does my personal credit score matter?
When you're a small business owner, your personal credit score matters just as much as your business credit score. Lenders see a small business as an extension of the owner's persona because their finances are so intertwined.
What makes up a credit score?
Personal credit scores comprise five factors.
- Payment history: This tracks if you've paid your bills on time.
- Credit utilization: This is the ratio of the current balance versus your credit limit on the credit cards and lines of credit you have. You want this number to be as low as possible.
- Mix of credit: This is the variety of your credit accounts, including revolving credit (for example, credit cards) and amortizing loans (for example, a mortgage or auto loan).
- Average age of credit: Lenders like to see a higher average age of accounts.
- Recent inquiries: Try to keep your inquiries for new credit to a minimum.
Your payment history and credit utilization make up almost two-thirds of your score, so pay the most attention to them.
Take steps to improve your credit score
If your credit score is lower than you'd like, don't worry – the number isn't etched in stone. You can take immediate steps to start improving it.
Make payments automatic
Maintaining a positive payment history is critical. It is weighted the highest – 35 percent – of any other credit score factor. I recommend establishing automatic payments of (at least) the minimum amount due so you won't have any late payments. As an added bonus, automatic payments also eliminate the possibility of being charged a late payment fee.
Keep in mind that this method won't pay off your balance, so you'll need to manually pay the rest of the statement balance to avoid paying interest.
Reduce and consolidate your debt
Credit utilization is the second biggest factor in your credit score at 30 percent. Ideally, you should keep balances in the 1 percent to 10 percent range of your credit limits. Pay your credit card balances down as much as possible to increase your credit score.
If your balances are higher than 30 percent of your credit limits and you cannot pay them down quickly, consider consolidating your debt into a term loan. This will immediately lower your utilization ratio and your credit score will improve. The term loan also contributes to a diverse mix of credit, which can boost your score.
Once your credit cards are paid down, do what you can to not run up your credit card balances again.
Dispute incorrect information
The Consumer Financial Protection Bureau reported 43,206 complaints against credit reporting in 2016. Of those, 74 percent were about incorrect information listed on a credit report. These errors could be affecting your credit score.
The federal government provides one free credit report to each credit bureau each year. Go to AnnualCreditReport.com to download yours. If you find any errors, contact the credit bureau to dispute the incorrect information and clean up your credit report.
You have five options for getting a loan right now
While you are working to improve your credit score, there are several lending options available to you. Yes, even if you have a low credit score. The interest rates will be higher, and the terms won't be as favorable; however, as you improve your credit score, you can refinance your loans to receive a better rate and terms.
Here are five ways to get a business loan with bad credit.
Microloans are small business loans of $50,000 or less. Business owners can apply for these at alternative lenders, such as credit unions, the SBA or online lenders, such as Lending Club.
Business credit card
Business credit cards are an option to diversify your credit history. In most cases, the inquiry will report to your credit bureau, but the account will not. Most tax professionals advise business owners to keep their personal and business expenses separate. Having a business credit card is a good way to do that.
Home equity line of credit
Home equity lines of credit offer cash at a low interest rate. If the account is not already established, the process can take four to six weeks for underwriting and appraisal of your home. Be cautious with this type of lending, since you are putting your home at risk in the event you default on the loan.
If your business holds inventory or has outstanding accounts receivable, factoring companies will lend you money against a percentage of those assets. The interest rates can be high, but the approval rates are good.
Your friends and family want to see you succeed, and some may be willing to lend to or invest in your business. I usually advise using this as a last resort because of the potential consequences if the loan goes unpaid.
Even with bad credit, you have options for small business loans
If you have bad credit, options exist that let you borrow money to grow your business. These alternative options may be more expensive than a traditional bank loan, but they can serve as a bridge while you improve your credit score. Even if you don't need to borrow money today, take steps now to boost your credit score so that you can get approved for the best rates and terms when an opportunity presents itself.