Several aspects go into running a successful business. One of the most underrated aspects that are often ignored by entrepreneurs or business owners is the personal credit score. It plays a crucial role when the business needs to borrow capital for further growth. Lenders and banks usually consider a loan application based on the applicant’s personal credit score.
Let’s first begin by understanding personal credit scores.
What is a Personal Credit Score?
A personal credit score is a reflection of an individual’s loan repayment track record. The credit score is calculated based on information sourced from banks and other financial institutions. The credit score is calculated by credit rating agencies and it generally ranges between 300 and 900. It is ideal to have a minimum personal credit score of 750 to be eligible for a business loan.
Do Small Business Loans Check Personal Credit?
Here are a few important points on how a personal credit score can impact small business loans:
- Eligibility criteria – Personal credit score is one of the important eligibility criteria considered by most banks and financial institutions. This is especially noted while reviewing the borrower’s business loan application form. A poor credit score can hamper your chances of getting a business loan approval and the business may have to use alternate sources to raise money. A bad personal credit score puts you in the category of risky applicants and increases the rate of interest. On the other hand, a good credit score allows you to get bargaining power as far as the interest rate is concerned.
- Company credit report – Similar to personal credit score, companies have something known as a credit report (CCR) which is a summary of a company’s credit history. CCR is generated based on the data gathered from banks and financial institutions. CCR is not a credit rating but it is a report that is closely scrutinised by banks and institutions before granting business loans.
- Correlation between business credit score and personal credit score – Many times, businesses struggle to get a loan based on the owner’s personal credit score. However, a bad business loan credit score can equally hamper one’s personal credit score too. Your professional and personal credit behaviour may be considered separately; however, a small business owner is the face of the business. Therefore, your personal credit score is closely scrutinised just like the business credit score.
- When is personal credit score evaluated – Most banks and lending institutions evaluate your personal credit track record irrespective of whether your business is small or big. In case you do not have a pre-existing relationship with the bank, they may especially check your personal credit score.
How Personal Credit Score Impacts Different Businesses
- Proprietorship Business:
In a proprietorship business, banks and lenders consider your personal credit score as your business credit score. These types of businesses often do not differentiate between the business and the owner. As per law, sole proprietors are considered liable for the debt of the business. Therefore, if the proprietor defaults on the business loan, it directly impacts his/her personal credit score.
- Partnership Business:
Partnership businesses are very similar to sole-proprietorship businesses. Here, your personal credit score is equally important. In such cases, partners are considered liable for a limited amount of debt. A lender may inquire about the credit details of all the partners in the business before granting credit or business loan.
- Limited Company:
In the case of a limited company, there is a unique corporate identity and the shareholders are not liable for the company. However, lenders may ask for the personal credit details of the senior management such as directors, business owners, etc.
The points mentioned above indicate that whether a business is small or big, there is no respite since your personal credit profile is directly linked to the business. Therefore, it is critical for a small business owner to have a good personal credit score and give equal attention to business credit score.
How to Ensure a Good Credit Score
Here are top tips on getting a good credit score:
- Avoid payment defaults: Your personal credit score is calculated as per your track record of repaying EMIs on time or before the due dates. To get a good credit score, make sure that you pay your credit card bills and loan EMIs on time.
- Take loans as per affordability: Always take only that much loan which you can repay. This will help in maintaining an excellent personal as well as business credit score. Debt should never exceed your income; else it can act as a red flag in the credit report.
- Avoid multiple loans: The intent of taking a business loan should be justified and you should be careful about taking too many loans at once since it can impact your credit score negatively. Too many loan applications or rejected loan applications can damage your credit score. Only apply for business loans that you plan to fully use and always have a repayment structure ready.
Additional Reading: Learn how to improve your personal credit score before making a business loan application.
A personal credit score may be overlooked while making a business loan application. However, all business owners who are looking to source some form of credit should understand that a personal credit score can significantly impact the chances of easily getting a business loan and also the loan terms.