Which small business loan should you choose, according to your credit score?
Below is some additional information about the loans available for each bracket of credit score and what these loans entail. Although there are minimum credit score requirements for many types of loans, you should keep in mind that qualifying for a loan doesn’t necessarily make it the right option for you.
SBA loans are some of the most desired funding options among small business owners. They offer the highest loan payouts – up to $5 million – and the longest loan repayment period of any comparable type of financing. However, applying for an SBA loan is notably complex – these loans are government-backed, so there’s lots of paperwork. But a trusted partner like SmartBiz can help you through the process and provide you with personal help.
Interestingly, SBA loans technically don’t have official credit score requirements. However, they’re essentially available solely to high-score applicants. That’s because banks service these loans, and banks are notoriously risk-averse. It’s also due to the large number of applicants you’ll be competing against for eligibility. Given this all, a good rule of thumb is to have some prior experience running a business and a FICO score of at least 680. Checking those two boxes puts you in a better position for an SBA loan.
Loan packages from traditional lending institutions such as banks are often just as desirable as SBA loans. Banks and credit unions typically provide loans with extended repayment periods, lower interest rates, and large loan amounts. But as with SBA loans, bank term loans are only available to the most eligible borrowers. After all, as financial institutions, banks often have the most stringent requirements.
Most bank loan applicants must have significant prior experience in business. You’ll also need a highly profitable idea for a company (or a business that’s already successful) and a high credit score. While the minimum credit score required can vary, having one in the low 700s or high 600s gives you the best chance at qualifying.
The purpose of equipment loans is, as the name suggests, to finance the purchase of equipment you need to operate your business. However, in return for the funds you borrow, the equipment you obtain gets put up as collateral. Consequently, if you fail to repay your loan, the lender can seize the equipment to recoup their losses. The advantage for you is that, generally, none of your other assets can be seized – which is possible with other loans – but you’re left without equipment.
Since lenders aren’t taking on as much risk due to the collateral inherent in the loan agreement, equipment lenders may accept somewhat lower credit scores. To be eligible, you’ll likely need a minimum rating of around 630.
Alternative lenders often offer short-term loans. These loans are mainly characterized by fast payout, short repayment periods of three to 18 months, and high interest rates. Though you can get your funding quickly, your loan amount will usually be at most $250,000.
Short-term loans are accessible to most borrowers, but the recommended minimum credit score is around 600. While it’s possible to qualify with a lower score, you’ll likely have to pay a higher interest rate to cover this gap.
A hard money loan is typically a last-resort option. It works similarly to equipment financing, but commercial property is used as collateral in return for funding.
Proper financial institutions typically don’t offer hard money loans. Direct private lenders do so instead. The result is often a lack of oversight and regulation. That means your fast funding time may come with higher interest rates, shorter repayment periods, and greater financial risk.
Hard money loans can be valuable for small business owners with poor credit. Typically, lenders don’t look into a borrower’s financial background for these types of loans, as the value of the collateral property is more important for approval.
Why do credit scores matter when applying for a small business loan?
Your credit score is the quickest way for lenders to measure your potential risk as a borrower. If you’ve historically been unable to repay your debts, banks and other lenders have no reason to believe you’ll repay their loans. By contrast, your financial history could show that you pay your bills on time and you haven’t experienced considerable financial challenges such as bankruptcy. The result is that you’re more likely to qualify for loans because you’ve demonstrated your ability to pay them back.
Additionally, some lenders will offer better terms to applicants with higher credit scores. For example, let’s say you’re applying to a loan that requires a minimum credit score of at least 650. Were your credit score 650, you’d qualify, but you’d probably get a good-but-not-great deal. Were your score 800, you’d likely qualify for the most favorable terms – long repayment periods, low interest rates, and more.
How to improve your credit score
A poor credit score can place many borrowing opportunities out of reach, but you may be able to take steps to help get yourself out of that bind. If your credit score isn’t where you’d like it to be, below are a few methods to help you improve it over time.
- Regularly review your business credit reports. Properly tracking your credit score means reviewing several near-constantly changing factors. Credit rating agencies are constantly checking these variables, so you should too – you might even spot inaccuracies. Staying on top of your credit reports helps ensure that discrepancies do not needlessly restrict you from financial opportunities.
- Pay your bills on time. A steady stream of paid-on-time accounts is ideal, but circumstances can get in the way. While partially paying your bills isn’t a perfect solution, doing so has a less negative impact on your credit score than entirely missing repayments. Putting your bills on auto-pay works too, though you’ll need to be sure there’s enough money in your account to cover your payments. If not, your account will go into overdraft, which lowers your credit score.
- Keep your personal and business finances separate. Never spend business funds on your personal expenses or vice versa. Doing so is a fast way to mess up one or both of your financial histories. These mistakes can be hard to correct. That’s especially true when it comes to taxes – paying personal rates on corporate income can lead to overspending. That overspending leaves you less room for repaying bills, leaving you more prone to a lower credit score.
- Try to prepay bills. Going after delinquent payers is a stressful and time-consuming process for your vendors. That’s why, rather than accept the risk of non-payment, some of your vendors may incentivize prepayment. For example, a lender may offer discounted rates if you pay early. The extra cash that you keep can significantly increase your cash flow. Plus, prepayment provides more control over your payment schedule and helps you avoid missed bills.
A good credit score unlocks opportunities
Credit scores can be hard to influence, but they’re vital to obtaining small business funding. That said, even business owners with poor ratings have options for growing or sustaining their companies. And with time and effort, you can grow a poor credit score into one that makes you eligible for the best loans around.