Opening up a new business is a life-changing decision. You have to commit to a significant amount of work in a short period of time, and you’ll need enough financing to get the ball rolling. However, a bad personal credit score can prevent you from scaling as quickly as possible.
The Relationship Between Personal and Business Credit
When you start a business, you typically won’t have a business credit score. That isn’t an issue for lenders if your personal credit score is 700 or higher. Lenders will initially use your personal credit score for financial products you’ll use for your business, but this eventually changes.
The longer you stay in business, the more likely lenders are to use your personal and business credit for business lending. While a bad business credit score won’t affect personal lending, a bad personal credit score may affect business lending, even if your business credit is high.
Ideally, you’ll keep both credit scores high to keep your business finances equally high. Pay attention to the things that can negatively impact your credit score to avoid financial difficulties.
Understanding What Affects Your Credit Score
Personal and business credit are affected by similar factors, but there are a few things that make them distinct. Here are a few ways personal FICO and business credit scores differ:
- Personal credit scores range between 300 to 850, whereas business credit scores range from 0 to 100. You need a minimum of 600 (personal) or 75 (business) to get a loan.
- Consumer lenders use Equifax, TransUnion, and Experian, whereas business credit uses Equifax, Dun & Bradstreet, and Experian. FICO and VantageScores for consumers are standardized, whereas every business lender will use a different formula.
- You can monitor your personal credit scores for free from multiple lenders. For example, you can use apps like SoFi to monitor your credit score safely. However, it will be difficult to find an app that lets you view your business credit score for free at any time.
When it comes to the factors that make up your credit score, personal and business credit won’t differ significantly. Here are the credit similarities between your personal and business score.
- Payment History: Your payment history is a record of whether you pay your bills on time. This accounts for 35% of your personal credit and varies for business credit.
- Credit Utilization Ratio: Your ratio is calculated by comparing how much revolving credit you had and how much you’ve used. This accounts for 30% of your credit.
- Credit History: Your credit history is calculated by looking at the average age of your combined accounts and your oldest account. This accounts for 15% of your credit.
- Account Mix: Your account mix looks at how many installments and revolving accounts you own and populates a score. This accounts for 10% of your credit score.
- Credit Inquiries: Your percentage will go down if you make too many hard inquiries, but soft inquiries don’t affect your score. This accounts for 10% of your credit score.
Once you get a business credit account, you also have to consider business longevity, your annual revenues, assets, public records (for liens and judgments), and industry risk.
The effects of low credit scores on business finances
Your credit score will drastically decline if you continually make bad loan judgments. Once that occurs, it will be difficult for you to get finance, which might cost you your firm.
1. Increasing Loan Rates
Lenders will charge you higher interest rates on loans if your credit score is 699 or below and your business credit score is 79 or lower. According to NerdWallet, the difference in interest rates between personal loans for excellent credit and poor credit may range from 5% to 36%.
2. Limited Loan Potential
Banks might tell you’re a high-risk client if you have a poor credit score. Low-interest loans won’t be as accessible to you, and you could not be approved for certain financial products. You may not be able to purchase the tools or other necessities as a result.
3. Costly Insurance Premiums
Even when it’s not true, insurance firms often associate a low company credit score with unethical business activities. In any case, insurance providers will use this as justification to raise your premiums to protect themselves. As a result, you have less money to invest in your company.
4. Expensive Vendors
Vendors won’t do business with organizations that have a track record of late or overdue payments. Additionally, merchants converse. It won’t take long for the other vendors to realize you can’t be trusted once one does. There won’t be as many alternatives available to you, therefore you’ll have to accept expensive vendor prices.
5. Costly Utility Bills
High electricity expenses won’t be an issue if you run an eCommerce or dropshipping firm. However, if you possess a warehouse to keep your goods, your electricity expenses would probably be greater than those of the typical company owner. These costs can start to pile up quickly.