Your personal credit score is very important for most small business owners looking for a small business loan. Many lenders still use the personal credit score as a go-no-go metric for business loan approval. Even through your personal credit score offers an incomplete picture of your business’ creditworthiness, for most small business owners the need to build and maintain a good personal credit score is likely never going to go away.
With that in mind, it’s important to understand how your credit score is calculated and how it could impact your ability to get a business loan.
What Does My Personal Credit Score Say About Me?
Your personal credit score gives a lender a look into your past to help them predict your credit behavior in the future. While there are some circumstances that negatively impact the credit score of an otherwise good borrower, here is what most lenders see when they review your personal credit score and how that could impact your ability to find a small business loan:
Below 579: Bad
There is some financing available for borrowers with this type of credit score, but it’s considered a high-risk loan and will likely come with higher interest rates. It’s very unlikely this borrower would be able to qualify for a traditional bank loan or a loan from the SBA.
Although there are financing options available, it is unlikely this borrower would find success at the bank. And, a borrower with this credit score should expect to pay a high interest rate. This score is also considered a higher-risk credit score.
This is considered a moderate-risk credit score. A small business loan is very possible, but will likely not come with the lowest interest rates. If your personal credit score falls within this range, expect to pay a moderate to high interest rate. A 650 credit score is the bottom threshold the SBA will typically consider.
This is considered a good score and many in the U.S. fall within this range. A borrower with this type of score can expect to see more approvals and better interest rates. A score of 680 is typically the lowest a bank will consider.
720-799: Very Good
If your credit score falls within this range you are considered a low-risk borrower and will be able to find a loan just about anywhere. A borrower with this credit score should expect to be offered excellent interest rates along with other possible perks.
Above 800: Excellent
If your personal credit score is above 800 you can expect lenders to roll out the red carpet. Borrowers with this credit score will be offered the best interest rates and the most favorable terms.
How is My Credit Score Calculated?
The formula used today to calculate your personal credit score was first introduced in 1989. Unlike your business credit profile all three of the major personal credit bureaus, Experian, Equifax, and Transunion, use a very similar system to calculate your score. While there are some slight differences, the information they look at is pretty straightforward:
- 35% Payment History: Late payments, bankruptcy, judgments, settlements, charge offs, repossessions, and liens will all reduce your score.
- 30% Amounts Owed: There are several specific metrics including debt to credit limit ratio, the number of accounts with balances, the amount owed across different types of accounts, and the amount paid down on installment loans.
- 15% Length of Credit History: The two metrics that matter most are the average age of the accounts on your report and the age of the oldest account. Because lenders use your score to predict future credit worthiness based upon past performance, the longer (or older) the file the better.
- 10% Type of Credit Used: Your credit score will benefit if you can demonstrate your ability to mange different types of credit—revolving, installment, and mortgage, for example.
- 10% New Credit: Every ‘hard’ enquiry on your credit has the potential to reduce your score. Shopping rates for a mortgage, an auto loan, or student loan will not typically hurt your score, but applying for several credit cards or other revolving loans in a short period of time could. According to Experian, these enquiries will likely be on your report for a couple of years, but have no impact on your score after the first year.
How Can I Improve a Low Score?
Building a good credit score or rebuilding a less-than-perfect score isn’t something that happens overnight, but there are some things you can start doing right away that will yield results fairly quickly. Here are four things you can start doing today:
- Know Your Score: The best place to start is by looking up your current score. The three major credit reporting agencies all offer a free annual credit report as well as other services to help you keep track of where you are. They also offer an alert service that notifies you any time your credit is checked or changes. There are several other places that offer the same type of services at very low or no cost.
As you review your report and your score, look for errors. It’s not uncommon to find mistakes on your personal credit report. The major reporting bureaus all have dispute procedures in place and will correct any verifiable errors on your report.
- Keep Your Personal Credit and Your Business Credit Separate: While it’s tempting (especially in the early years) to use your personal credit to cover business expenses, it’s not a good idea in the long term. It doesn’t help to build your business credit and the higher balances usually associated with paying for business expenses can actually hurt your personal credit. Remember 30 percent of your personal credit score is a reflection of how much credit you actually use verses how much credit you have available. In other words, if you’re maxing out your personal credit cards every month, it will hurt your personal credit score. This is true even if you pay the balance down every time a payment is due.
- Don’t Apply for Credit You Don’t Need and Don’t Jump Around: Every time you apply for new credit it impacts your credit score. Applying for credit you don’t really need will hurt your score. And, moving balances around is not a good strategy to improve your score; it’s considered a very transparent gimmick that will hurt your score. Plus, don’t forget the longer you’ve had a credit account the more positive the impact on your score, so closing one credit account to open a new account doesn’t help you.
- Stay Current on Every Credit Account: The single biggest thing you can do to improve your personal credit score is to make timely payments on all your credit accounts. Once you start missing payments, it doesn’t take long for your score to drop. If your credit score is suffering, you won’t be able to change things overnight, but your diligent efforts will yield results. Before too long, consistent monitoring and good credit practices will help you improve your score.
Don’t believe anyone who claims they can drastically improve your credit score overnight. Aside from correcting errors on your report, there are no quick fixes. You should also know that it’s against the law for anyone who claims they can fix your credit to ask for payment before they go to work. Additionally, it’s against the law for you to use an alternate social security number to create a new credit alias. Fixing a less-than-perfect personal credit score simply takes time and good credit practices.