Oddly enough, one of the most important parts of any small business credit relationship is the business owner’s personal credit score. Why? When a lender or supplier extends credit to a
small business, they naturally assume it is the business owner that is going to be responsible for managing the credit line (and paying it back). And, they’re right.
This can often be surprising to business owners; therefore, it is important that you inform your clients how crucial it is for them to maintain healthy credit throughout the life of their business.
If your client asks you for advice on how to give their credit score a boost, remind them that nothing is guaranteed nor can it be fixed over night. However, feel free to offer the following suggestions, which research shows have the biggest effect.
Complete accurate and consistent identification on credit applications. Doing so helps set up their credit history correctly from the beginning. It also minimizes the chance that their credit file will be incomplete or mixed with another consumer’s file. So when they apply for credit, they should print clearly and consistently using their complete name. When applying online, they should be thorough and consistent, and type carefully.
Set up a budget and live within it. Credit is a financial tool, but it isn’t something that should be used to live beyond their means.
Always pay bills on time. The most recent information on a report is more important. So if they’ve paid their accounts on time for the last two to three years, a few late payments from five years ago may not prevent them from getting new credit, although it might cause them to pay higher interest rates or fees.
Have some credit but not too much. Having no credit history is almost as bad as having a negative credit history. If they have paid one or more accounts as agreed, they have shown they can manage their finances responsibly.
Keep balances well below credit limits. High utilization (balances close to credit limits) often indicates high risk on additional debt. Ideally, they should pay their balances in full each month. While credit is a financial tool, they should avoid debt.
Have a mixture of credit types. It is good to have a history of repaying an installment loan, but a revolving (credit card) account is even more predictive of credit risk because they must manage their balance and monthly payment.
Apply only for the credit they need. Several recent inquiries may indicate they have opened new accounts that don’t yet appear on their credit report, indicating potential new debt that could affect their ability to repay another loan.
Be aware of their debt-to-income ratio. While income is not part of your credit report, lenders will consider their monthly payments compared with either their monthly income or monthly cash flow. (Income for a consumer loan, cash flow for a business loan.)
Demonstrate stability. Some creditors consider their length of employment, length of residence, whether they own or rent, and if they have any savings.
Use caution when closing accounts. Closing an account isn’t always a good thing. It can increase their balance-to-limit ratio, making them appear to be an increased credit risk.
Have a plan. Be accountable for their decisions and know how they are going to repay their debts.
Building credit history is certainly a marathon -- not a sprint. But if you can help your clients understand the factors that most affect their score and history, you’ll help them open up a wealth of opportunities (such as easier access to small business financing), in both their business and personal life.
If you’d like more information on building personal credit, you can read our article here.
Want more information on how to help your clients find financing? Join the Fundera Advisor program here.