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This Credit Score Guide Can Help You Save Thousands on a Loan

You’ve figured it out:

How to take your business to the next level.

Maybe you need another vehicle or two. Or an updated, state-of-the-art piece of equipment. It could be that stellar employee you just interviewed, or it might be you’ve done the math and it’s the right time to double your inventory.

But whatever it is…

You know it’ll give you the bump you need. More customers, higher revenue, better brand recognition: whatever your goal is, this project will accomplish it.

Just one problem: How can you afford it?

That’s why people turn to business financing—so they can borrow money to grow.

You probably know all this. But do you know the single most important factor in applying for a business loan? In qualifying for the financing you need? In getting affordable funding?

We’ll give you a hint—it’s in the title of this post.

That’s right: your personal (not business) credit score matters more than anything else. At least when it comes to qualifying for funding you can afford.

In this credit score guide, we’ll take a look at why your credit score matters, how it affects your business financing, and what improving your credit can do.

Your Credit Score Guide to Why Personal Credit Matters

It might have surprised you to hear just how big of an effect your personal credit can have on your business financing.

Saving thousands? Come on—that can’t be true.

It is, and we’ll prove it… But first, let’s just remind ourselves of a few important facts about personal credit scores.

What’s a Credit Score? Quick Reminder

Here’s the deal:

Your credit score is basically meant to measure how reliable you are.

Specifically, how responsible you are with your financial obligations.

When a potential lender looks at your credit score, they’re asking themselves a few questions:

  • Does this person pay back what they borrow?
  • Are they on time with their payments?
  • Are they consistent with their payments?
  • Do they take on too much debt at once?
  • How long have they been borrowing money—and paying it back?
  • How many different kinds of credit do they have?

In other words, lenders use your credit score to decide…

“Can I trust you?”

Suddenly that three-digit number doesn’t seem so unimportant, does it?

Let’s talk about how a credit score works, and then we’ll dig into why it’s used as a shortcut for your financial reliability.  

How Your Credit Score Works

There are 3 main bureaus that monitor your personal credit score: Experian, Equifax, and TransUnion.

They each have their own unique formula, but all of the bureaus plug in more or less the same factors to determine your credit score.

We don’t know those formulas, or how each bureau weighs the variables they look at, but we have a good idea of what matters and what doesn’t.

Here are some of the variables that go into your personal credit score calculation:

  • Amount of debt you’ve taken on
  • Average age of your open credit accounts
  • Diversity of your credit accounts (what kinds of loans have you taken out?)
  • Payment history—including bankruptcies and judgments
  • Tax liens
  • Hard credit checks (but soft credit checks, like when you look at your own credit, don’t affect your score)
  • Credit utilization (in other words, how much of your available credit do you actually use?)

Each year, you’re allowed to get one free credit report from every credit bureau for free.

Not a bad deal.

Make sure to take advantage of this and check, not one, but all three credit reports. There might be errors that could be seriously impacting your credit score—without you being aware.

(In fact, studies show that around 1 in 5 credit reports have errors… And when corrected, these credit scores actually increased. If that’s not incentive for you to check your credit score for free, we don’t know what is.)

Personal credit scores usually range from 300 to 850. Here’s the breakdown of what each bracket means, generally speaking:

  • Excellent: 781 – 850
  • Good: 661 – 780
  • Fair: 601 – 660
  • Poor: 501 – 600
  • Challenged: Below 500

Now that you understand what a credit score is, it might seem a little clearer why it matters.

What’s the Big Deal with Your Credit Score?

Like we said, your credit score measures your reliability.

Why?

Lenders—including banks—are using those questions and numbers from earlier to decide, based on your past habits, whether you’ll repay future loans.

Here’s a simple analogy:

If your friend always asks to borrow a few dollars for coffee whenever you get together, but only pays you back half of the time…

You’re probably going to stop financing their caffeine.

Similarly, if a lender sees that you generally pay your loans back late, they’re much less likely to offer you their business.

And why would they? It’s their money they’d be trusting you with.

It’s not a perfect science, and different lenders have different thresholds for what credit scores they need to see…

But overall, your credit score is a good measure of how you repay your debts, what kind of credit you look for, how well you understand the amount of debt you can actually take on, whether you’ve successfully avoided bankruptcies and tax liens, and more.

Essentially, the factors that determine whether you’re a good borrower. And since your small business is just that—small!—your personal financial habits will match up with your business’s.  

When we put it that way…

It makes total sense why a lender would care about your personal credit score.

Your Credit Score Guide to How Your Credit Impacts Your Financing

Lenders care about your credit score.

OK, great—got it.

But exactly how will your credit score affect that business loan you’re looking for?

There are two basic ways. Let’s break ‘em down:

1. Better Credit = Better Eligibility

Business financing comes in all different shapes and sizes, from the big and affordable SBA loans to smaller, shorter-term solutions… As well as some kinds of loans that use your equipment or outstanding invoices as collateral.

The point?

Not all loans are created equal—and not all borrowers can qualify for the same kinds of financing.

So what determines whether you qualify for this loan or that?

There are a lot of factors—from your annual revenue to how long you’ve been in business for—but if you’ve read this far, you can probably guess the big one…

That’s right: your credit score.

According to data we gathered from 2,500 loans, totaling roughly $140 million distributed to over 22 million small business owners (for our Q1 2016 quarterly report), your credit score is a major factor in your loan eligibility.

Eligibility & APR Ranges by Loan Product

(Note that this chart only shows the interquartile ranges, or the data between the 25th and 75th percentiles, in order to highlight the average experience.)

We only looked at five kinds of loans here: short-term loans, short-term lines of credit, medium-term loans, medium-term lines of credit, and SBA loans. We didn’t look at invoice financing, equipment financing, startup loans, merchant cash advances, or personal loans.

But the main takeaway is the same:

Your credit score can limit the kinds of loans you’ll qualify for…

Or open doors to more options.

Which means the higher your credit score, the more choices you have. There are still business loans for bad credit, but as you can see, the loan products with the highest credit score requirements also have the lowest APRs.

So, more about that…

Understanding Your APR

Before we get into the relationship between your credit score and your loan’s cost, let’s hold a quick Credit Score Guide review session:

What is “APR”?

Excellent question.

First of all, APR stands for Annual Percentage Rate—which means, essentially, the annual cost of your loan.

In other words, your APR measures how much a loan will cost you over the course of a year. This means you can compare loans of different term lengths and still understand how their costs relate.

But how is your APR different from your interest rate?

Another good one!

Your interest rate just calculates how much interest you’re paying on the principal—or the amount you’re borrowing.

APR, on the other hand, takes into account things like:

  • Closing fees
  • Origination fees
  • Insurance costs
  • Underwriting fees
  • Processing fees
  • Document preparation fees
  • Application fees

Not every lender includes these extra expenses, but some do—and the APR is where you’ll see how those costs affect your loan’s price tag.

Okay… So why is the APR important?

Well, let’s put it this way:

If you’re shopping for a car, you wouldn’t just buy the first one you find, right?

Nope—you’d compare options and prices to get the best deal.   

You should be doing the same for business loans…

And that’s where APR comes in. Because a loan’s APR takes all of its costs into account and averages them out to a year, you can compare drastically different loans without winding up confused or mistaken.

APR gives you the true cost of your loan—and takes the guesswork out of the process.

So, how about those credit scores?

2. Better Credit = Lower Rates

Like we saw above, there’s a definite relationship between credit score and APR.

Let’s take a closer look:

Data Piece - APR vs. Credit Score

This data, taken from our quarterly State of Online Small Business Lending (Q3 2015), encompasses 1,300 loans and $63 million in financing.

Unsurprisingly, there’s a direct connection between your personal credit score and the loan product you’ll wind up with.

Just a note about the data: this shows a very strong correlation, but not necessarily a causation. In other words, we can’t quite say that a higher credit score causes your loan to have a lower APR…

But we can say that 97.1% of the variation in median APR can be explained by the average credit score.

And that’s a lot.

Basically, the higher your credit score, the lower your loan’s APR—because you’ll qualify for a more affordable loan product.

But having a better credit score doesn’t close you off from the more expensive, shorter-term options if you need them:

Maybe you’ve run into an emergency and need financing tomorrow, for example.

Even if meet SBA loan requirements, it would take weeks to reach your bank account—so you’ll pay more for that faster cash. But with a higher credit score, at least you had the choice.

One Lesson From the Credit Score Guide: Never Settle

If your credit score won’t give you access to the kinds of loans you want, don’t despair.

You can always seek out business financing now and graduate into a more affordable loan when your credit score hits a certain benchmark.

That’s how you save money for your business—while growing it.

Improving Your Credit Score + Refinancing = Saving Money

For example, say you’ve got a credit score of 550 and started off with a short-term loan:

$100,000 with a year-long daily repayment schedule and a 33.54% APR. That’s 264 daily payments of $446.96, making a total of $118,000 you’ll be repaying.

By spending that money wisely and building up your credit score, you’re able to refinance that debt into a medium-term loan—and, eventually, an SBA loan.

Now armed with a credit score of 680, you’ve qualified for:

$1 million in business financing at a 6% APR for 10 years. You’re paying $11,102 each month, and $1,332,246.02 in total.

For some perspective, that short-term loan amounted to $9,833 each month…

So for a bit over $1,000 per month, you’ve taken out nearly ten times as much financing.

Just by raising your credit score and refinancing your debt.

And this isn’t a fantastical situation:

It’s real, and we see it happen all the time.

Let’s take a look at an actual example.

Saving Thousands: A Case Study

About a year ago, one of our business owners came to us with a credit score of 590 and a merchant cash advance in hand.

Not realizing that a merchant cash advance is the single most expensive kind of business financing available.

He might have been paying a 65% APR on $20,000, with payments getting taken out of his daily credit card transactions.

We were able to refinance that merchant cash advance into a short-term OnDeck loan of $45,000 at a 45% APR.

Still not cheap, but that’s double the money for a much lower cost.  

This business owner could also now focus on building up his credit—and once he reached 640, the magic happened.

He refinanced—again—into a medium-term loan with Bond Street.

The terms?

$80,000 over 3 years, at 17.5% APR.

That’s going from $125 each day with the merchant cash advance—or $2,750 per month on average—to $2,872 once per month. For 4 times as much money.   

Needless to say…

Improving his credit score went a long way for this entrepreneur’s small business.

Ways to Improve Your Credit

This wouldn’t be a credit score guide if we didn’t help you improve your credit, would it?

Here are some tips to raising that all-important three-digit number:

1. Pay your bills on time.

This is the most important factor to get in control of. If you’re regularly making late payments—or missing them altogether—then you’re hurting your credit score in a big way.

Check if you can set up automatic deposits or create a calendar and reminder system that will keep you on track. Whatever works—as long as you’re paying your debts back in a timely way.

2. Don’t default.

This might seem obvious, but defaulting on your loan will seriously impact your credit score. Sometimes there’s no other option—and that’s probably why you’re in this position in the first place—but consider alternatives, like borrowing from friends or family, if you’re trying to raise your credit score.

3. Limit your spending.

Your credit utilization is how much of your available credit you actually use.

If you want to improve your credit score, it’s important to keep your utilization to 20% or lower.

Surprised?

It’s true. Even if you have a $50,000 line of credit, lenders will want to see that you spend that money wisely—which means keeping some cash in reserve in case of emergency.

4. Check your credit reports for errors.

Like we mentioned before, 20-25% of credit reports have some messed-up information—and if you correct those details, you could increase your score.

Sure, a report might just mistake your middle initial or add a credit check where there was none…

But if they erroneously add a tax lien or bankruptcy onto your file, you could be in trouble.

Use a site like AnnualCreditReport to get your three free reports and be on the lookout for:

  • Credit lines or accounts that aren’t yours
  • Incorrect judgments or collections
  • Accounts, judgments, or collections from your past that shouldn’t show up anymore
  • Misreported dates

5. Keep your personal and business finances separate.

This is more of a preventative measure:

By keeping your personal finances distinct from your business’s, you’ll protect your personal credit from any business downturns.

(And at the same time, you’re also creating a buffer for your business credit, which you’ll want to start building up, too.)

6. Keep old accounts active.

The average age of your credit accounts is actually an important factor in determining your credit score.

So if you’ve got an old credit card you never really use…

Keep the line open!

Dish that card out once a month—and make sure to pay it off—because the older your credit history, the better.

This also comes into play if you’re considering paying a loan off early.

Chances are, that won’t have a big impact on the average age of your open accounts…

But if it does, then you might want to think about paying it off according to schedule.  

7. Diversify your credit.

Although your credit mix doesn’t count for too much—just 10% of your credit score—it can be a factor that helps your credit score get that extra much-needed bump.

Instead of sticking to one type of loan, don’t be afraid to rely on credit for multiple reasons. You’ll prove to potential lenders that you know how to juggle a few payments at once, budget appropriately, and plan for the future:

All important skills to being a small business owner and a reliable borrower.  

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8. Limit your credit applications.

It’s a myth that your credit score gets hurt when you check it…

But applying for a few different loans at once?

That can definitely make an impact.

When you apply for a loan or credit card, your lender will carry out a hard credit check, which means they’re taking a close look at your credit report—and, as a result, you might receive a small penalty of 5 points or so.

This isn’t a punishment, though. It’s to prevent you from shopping for, say, a business loan and a car loan and a mortgage all at once.

That’s a pretty unsustainable amount of debt to take on—and, chances are, you won’t be able to manage it all.

However, you won’t get penalized for rate shopping: if you apply for a bunch of the same kind of loan within a certain time period, your credit score is safe.

***

So there you have it:

Raising your credit score could really, truly, seriously save you thousands on business financing.

You’ve seen the data. You’ve read the success stories. And you understand how your credit score works.

Now, what are you waiting for?

Go out and save your business some money!

Ben Rashkovich

Ben Rashkovich

Content Strategy Manager at Fundera
Ben is the resident wordsmith and grammar guru at Fundera. He makes sure their top-notch content stays accessible, interesting, and useful for small business owners. Previously, Ben wrote for the Columbia Spectator and eBay's curatorial team.
Ben Rashkovich