By: Alek Marfisi, EGF Consulting Corps member and owner of Upwind Strategies consulting.
Your credit score is an important factor for lenders and service companies that are gauging the likelihood of you paying your bills. Credit scores factor into most major purchases in our personal lives, including renting or buying housing, cell phone and internet services, applying for credit cards, auto purchases and more. What many people don’t realize is that their personal credit also affects their business and its ability to access capital.
A business owner’s personal credit score factors into all business credit decisions: if the people behind the business can be trusted, then there’s more reason to trust the business. In the past, personal and business credits were assessed consecutively in making credit decisions. Today, many lenders use a mash-up of business and personal credit in their decision-making, called FICO Small Business Scoring Service (FICO SBSS). Think of it as a mathematical product of your personal credit score and business credit score. This new way of looking at credit makes it more important than ever for business owners to pay careful attention to their personal credit, especially when seeking loans. Here’s how to keep your credit in tip-top shape:
Pay Your Credit Card Bills – At the Right Time
It goes without saying that paying your credit card bills on time maintains or improves your credit score, but when timed correctly, you can improve your score by 20 or 30 points in just a month. It’s all related to one of the most important factors of credit scores: debt-to-limit ratio. This is the ratio of your outstanding credit card debt to your respective credit card limits.
Consider the following example:
Kelly has a credit card with a $10,000 limit. Every month she spends about $3,000 on this card and pays it off entirely on the first day of the following month. Kelly is following all the rules and demonstrates great creditworthiness by doing so, but her score is perpetually stuck below 750. Looking at that card’s details on her Transunion credit report from CreditKarma.com, she sees the following information:
As you can see above, Kelly’s credit card company reports information to credit bureaus on or about the 18th of each month. Although she pays this card down to a balance of $0 at the beginning of the month, her credit card company reports her outstanding balance midway through the month. At this point, she has spent just over $1,500 and her debt to limit ratio is 15% ($1,500 / $10,000). The credit bureaus consider 10% or less to be ideal. To immediately improve her credit score, all she would need to do is switch up her payment schedule. By monitoring her credit report and paying her credit card balance off a day or two before the next time the creditor is scheduled to report information to the bureau, her reported balance will be near $0 and she can achieve a debt to limit ratio in the single digit range, tremendously boosting her score.
Raise the Roof: Increase Your Credit Limits
Also considering debt-to-limit ratio, increasing your credit limit will also directly improve your credit score. This is critical for business owners who rack up high monthly credit card bills by using their personal credit cards to make business purchases. Credit cards that we get in college or during our entry level working years have limits based upon our annual income at that time. If you’re still using a card from years ago, it might be time to contact your credit card company and ask for a limit increase.
Make a Schedule for Paying Personal Debt Used For the Business
Many entrepreneurs take on personal loans to fund their business. This option makes capital available to startup companies, but comes with a few downsides. First, this type of borrowing only affects the business owner’s credit score and not the business’s score. Also, personal debt is only half as effective as a business loan is at improving a company’s SBSS score. Second, it becomes easy to fall into the trap of keeping up with payments personally and falling behind on payments from the business. If you use personal debt to fund your business, make sure to set a rigorous schedule of making payments from the business to you, so you can make your monthly payment to your lender.
When it comes time to raise money for your business (and research shows that more than 60% of all small businesses need funding at least once a year), shop smart. Credit inquiries made by banks and lenders can lower your personal credit score, especially when they are made in rapid succession. If you’re planning on getting funds through a business loan or a personal loan that you’ll use for your business, keep bank credit inquiries to a minimum.
Whenever a bank or another lending or credit-granting institution does a credit inquiry, it’s called a “hard pull”. When you check your own credit score, called a “soft pull”. A hard pull will reduce your score by around five points, which adds up over time. Be smart when you apply for loans: before you contact lenders, obtain a copy of one of your reports through a soft pull, and submit it as part of your application. Lenders can use it as part of their prescreening process and tell you whether you qualify before they make a hard pull. Always try to keep the number of lenders you apply to for loans to a minimum.
Keep Old Debt on Your Report
Your credit history matters. When people finally finish paying off car and student loans, they usually rush to contact credit bureaus to have these loans removed from their reports. Keeping paid-off loans on your report helps to build your overall score and demonstrates to creditors your ability to handle debt.
Creditors make mistakes too! Many people are surprised to find incorrect or out-of-date information on their credit reports. This could include delinquent accounts that have since been paid off. Simply contacting your credit bureaus with documentation that proves their information to be incorrect can be enough to get these errors fixed.
Having a healthy credit score as a business owner means that your business is more likely to be able to access capital in the future. While the costs of living and cost of starting and running a business can be a burden, sticking to these few basic rules can help you to maintain your credit worthiness.
About Excelsior Growth Fund
Excelsior Growth Fund (EGF) helps businesses in New Jersey, New York and Pennsylvania grow by providing streamlined access to business loans and advisory services. EGF’s signature product, the EGF SmartLoan™, provides up to $100,000 in fast, transparent, and affordable financing through a secure online platform. Larger loans up to $500,000 are also available. EGF is a nonprofit organization and is certified by U.S. Department of Treasury as a Community Development Financial Institution (CDFI). Learn more at www.excelsiorgrowthfund.org.