For virtually every small business owner in the U.S., the importance of a good personal credit score when seeking a business loan can’t be underestimated. While it might feel counter-intuitive to be talking about your personal credit score when addressing a business credit need, a low personal score has been responsible for the undoing of many small business loan applications.
Lenders look at your personal credit history as a measure of your past credit performance and your willingness to meet your financial obligations. If you have a less-than-perfect credit score, making efforts to improve your score often results in more options, better terms, higher approval rates, and lower interest rates.
Do you know your personal credit score?
If you don’t, you should. What’s more, the three major personal credit bureaus: Experian, Equifax, and Transunion make it easy to access your score. And, for a modest fee, they’ll monitor your personal credit report and notify you every time something new is added or there’s a change.
Annualcreditreport.com is one place you can access your credit report for free once every year, but a simple internet search will reveal dozens of others—and many of them also offer low cost credit monitoring.
Editor’s Note: Though you can access free credit reports through Annualcreditreport.com, they do not include your credit score itself—you’ll have to pay for that.
How your score is calculated:
The personal credit score we use today was introduced in 1989 and includes data collected by the credit bureaus coalesced into a standard score from 300 to 850 (the higher the number, the better the score). The formula used for calculating the score 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 your personal credit score is trying to predict future creditworthiness 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 manage different types of credit—revolving, installment, and mortgage, for example.
- 10% New Credit: Every “hard” inquiry on your credit has the potential to reduce your score. Shopping rates for a mortgage, auto loan, or student loan will not typically hurt your score, but applying for credit cards or other revolving loans could reduce your score. According to Experian, these inquiries will likely be on your report for a couple of years, but have no impact on your score after the first year.
Tips for improving your score
There is no shortcut to improving a bad score. However, a focused effort over six months to a year can show a marked improvement in a less-than-perfect score. Alternatively, missing a payment or two can pull your score down significantly in a very short period of time. Here are a few suggestions to help improve a poor score:
1. Make payments on time. While this might seem like an obvious suggestion, the single biggest thing you can do to improve your score is to make timely payments on your credit accounts. 35 percent of your score is a reflection of how timely you pay your mortgage, auto loans, credit card payments, or other personal debt. Nothing else will have a greater impact on your credit score.
2. Don’t apply for credit you don’t need—Because credit inquiries can reduce your score, applying for unneeded credit could make improving your credit score more difficult.
3. Don’t try to shuffle your credit accounts—Transferring balances from one credit account to another doesn’t do anything to help improve your score and is considered a transparent gimmick that might actually lower your credit score.
4. Use credit wisely—This could be considered an oversimplification, but it’s important to avoid the temptation to max out your available credit. If the goal is to improve your credit score, try to keep your credit usage to around 15 percent of your available limit.
Remember: There are no shortcuts. Beware of anyone who claims to have a quick fix for a bad credit score—there isn’t one.
Your personal credit score will likely always be an important metric for any lender evaluating you and your business for a small business loan. Guard it like the precious business asset it is.
Have you turned your credit around? Share your experience repairing your credit in the comments below.