You probably know how important your credit score is when you’re applying for a small business loan. But do you know exactly what lowers your credit score?
With all the things that lower credit score, that number might come as a surprise when it pops up on your application. Still, as a small business owner, it’s crucial to keep your personal credit score as high as possible. Whether you need to replenish your inventory, do a major renovation, or simply have access to a source of working capital, it’s very likely that you’ll need some form of financing to run your business. And if you don’t have the credit score required for the business loan you want, you could have trouble growing your company.
That’s because lenders look to your credit score as an indication of your reliability as a borrower. Responsible credit holders—aka people who pay their bills on time and use their credit cards well below their limits—are deemed less risky to lenders, who want to know that they’ll be repaid everything they’re owed. So, those borrowers get access to more types of loans, higher capital amounts, and lower interest rates than borrowers whose credit scores have been dinged a few too many times.
This isn’t to say that you’re irresponsible if your credit score is low—every single credit holder makes mistakes. And if you’re handling many types of debt, you might have a tough time staying on top of all your loan payments.
So what lowers your credit score, and how can you avoid them? Consider this list of eight things that lower credit score a reminder of what not to do. You’ll keep your credit score high—and eventually get the best deal possible on your small business loan.
Your credit score is a numerical indication of your history with money. There are many, many types of credit scores out there, but the FICO score is by far the most common scoring system. (VantageScore is probably the second-best known name in credit scores.)
Initially, the FICO scoring system was used by lenders to gauge a homeowner’s ability to repay their mortgage. Now, all kinds of lenders take that score into account when determining whether to extend a loan, plus the terms of that loan. The higher your credit score, the more trustworthy lenders think you are with your financial obligations—which means you’ll have more loan options available to you, and at better rates.
Three major credit bureaus measure your credit score: Experian, Equifax, and TransUnion. FICO scores have been in use for more than 30 years, and they’ve made some changes to the scoring system along the way.
Scores range from 300 to 850 (and, yes, it’s possible to get a perfect credit score). Generally, the health of your credit score is quantified (and qualified) like this:
But! All three of the major credit bureaus might have slightly different information on consumers and weight different factors differently. So don’t be surprised if your credit number fluctuates slightly across your credit reports. (You can expect about a 20-point difference, so not dramatic.)
→Too Long; Didn’t Read (TL;DR): Your credit score is a measure of your historical responsibility borrowing money. Lenders will use that score to figure out whether they’ll extend you a loan, plus the terms of that financing. Lenders will most likely look at your FICO score.
Even though you might not be able to predict your exact credit score, there’s no reason to feel like you’re totally in the dark, controlled by a mysterious system. You can control the outcome of your credit score—at least a great majority of it.
Specifically, you can count on credit bureaus weighing the following five factors to calculate your score, plus the approximate percentage of your score they’ll account for. We’ll also tell you a little bit about what these factors entail, so you can know exactly what lowers your credit score in each of these categories.
1. Payment History
2. Credit Utilization
3. Age of Credit History
4. New Credit
5. Credit Mix
Before applying for a small business loan, it’s a good idea to check your credit score. That way, you’ll have a better idea of which types of loans and loan terms you’ll be qualified for, and you can adjust your expectations accordingly.
→TL;DR: Your credit score comprises some combination of your history of timely payments; how often you use your credit; the age of your credit history; new credit activity; and the number and types of credit accounts you have.
You know what activities make up your credit score. Now let’s talk about more specifically about what lowers your credit score. This is by no means an exhaustive list, but these eight actions are surefire ways for small business owners to negatively (and, in some cases, severely) impact their credit scores.
The only way to have a strong credit score in the first place is to borrow money… and pay it back. (Obvious, but true!) But be cautious about applying to too many credit cards and loans all at once. A lender will almost always make a hard credit pull of your credit report before extending you a line of credit or other type of loan, and hard inquiries cause a small dip in your credit score for a temporary period. But the inquiry will stay on your report for two years, regardless of whether the lender decides to extend you that loan or not.
FICO says that a single hard pull usually only lowers your credit score by five points or fewer. But many hard pulls in succession, of course, multiply that number.
In fact, any activity that requires a hard inquiry will lower your credit score, and those hard pulls can be sneaky. Other activities that might require hard pulls might include debt consolidation, loan refinancing, requesting an increase on your credit limit, and even renting a car. Take a look at our credit inquiry guide for a clearer picture of soft pulls, hard pulls, and when to expect them both.
Compared with the average American, small business owners are way ahead of the credit-score curve. According to a 2016 study by Experian, small business owners have an average personal credit score of 721, while the average consumer score is 673.
But that’s even more reason for small business owners to stay diligent about paying their bills on time—because the higher your score, the more late payments will cause your score to drop. And if you’re delinquent on your loan, of course, you’ll also be incurring the wrath of late payment fees and increased interest rates.
Lenders might forgive a late payment (30+ days overdue) here or there, but consecutive late payments will definitely hurt your score. And a late payment that exceeds 90 days will have the biggest impact on your score. Plus, it’ll stay on your record for seven (!) years.
Keep in mind that this applies for late credit card payments and other types of loans, like student loans, mortgages, and auto loans. Delinquent payments on a business loan may or may not lower your credit score. It really depends on the lender you’re working with and the type of loan they’ve furnished, so it’s best to contact your lender directly if you’re worried about making your payments on time.
The difference between a delinquency and a default is mostly a matter of time. A delinquency is when a borrower fails to repay their bill for about 30-90 days. Delinquencies will lower your credit score, but they can be cleared up by simply paying the owed amount, plus whatever fees have been incurred.
A loan default’s when a borrower consistently fails to pay their bills for even longer than that. Depending on the lender and the type of loan, the length of time at which a loan is defaulted can differ. Usually, though, it’ll be at some point over 90 days.
As you can guess, defaults are much harder to rectify than delinquencies, and the consequences are more serious. If the defaulted loan is collateralized, for instance, then the lender can seize the borrower’s assets to compensate for that missing debt.
Your credit score takes a serious hit if you default on your loan. It’ll stay on your record for six years, too, which can prevent you from securing loans in the future.
Another potential outcome of a defaulted loan is a charge-off. Basically, a charge-off occurs when you’re so late in your payments that the lender no longer deems your debt valuable. A charge-off isn’t a get-out-of-jail-free-card, either: you’ll still owe that money, and the bank might send a collection agency out to get that money from you. Obviously, a charge-off has a serious impact on your credit score, and even after the debt is repaid it’ll stay on your credit report for seven years.
The thing is, lenders don’t want to punish you for being behind on your loans any more than you want to be punished. So if you are behind on your loan payments, the lender will reach out to you to find out what’s going on. And they might be able to find a way to help you out, such as offering adjustments to your payment plan. If you suspect that you won’t be able make your payment on time, you can always contact your lender directly—before the possibility arises that your credit score will take a hit.
With so many great business credit card options on the market, it can be dangerously easy to sign on for a card that you think you need, but that, in reality, ends up languishing in your desk drawer.
But unused cards might lower your credit score, mostly because that card poses a giant question mark. Without spending information, the lender can’t assess your level of financial responsibility. Opening new accounts also decreases the average length of your credit history, which is another key factor that the credit bureaus take into account in calculating your credit score.
So, to protect your credit score, only sign up for new cards that will serve your business’s needs, and that you’ll regularly use.
Your credit utilization ratio is much more important to your credit score than the spending limit you have on that card. In reality, the credit bureaus don’t care about how much money you have to spend—they care about how well or poorly you manage that money.
As a general rule, your credit card balance shouldn’t exceed one-third of your credit limit. Any more than that, and the creditor might think you’re overly dependent on your credit card. Maxing out your credit card is a red flag, because it indicates to the lender that your ability to repay your debt might not be able to keep up with your spending habits.
Reading over your credit report might not make for the most riveting literature, fair. Still, it’s important to regularly check up on it to make sure all that information is copacetic. In other words, that all the information on the report is actually associated with your actions.
It’s possible that a lender reported a number incorrectly. It’s also possible that suspicious activity is the result of identity theft. Either way, it’s vital that you report incorrect information to the credit agency so they can look into the source of that error and amend your score accordingly. And if it looks like a lender misreported information, you can dispute that error with the lender itself.
All three credit bureaus give you one free credit report per year, and experts recommend checking one report from each credit bureau every four months. That way, you’ll check your credit score three times per year, rather than checking all three at the same time.
But feel free to check up on your score even more than that, and don’t worry about the effect on your credit score. When you request your own credit report, the bureau performs a soft pull, which, unlike a hard pull, won’t impact your score.
Canceling a credit card can affect a few factors of your FICO credit score, and eventually lower your credit score. First of all, eliminating a line of credit decreases your overall credit utilization, so you’ll probably have to decrease your spending on your remaining card accordingly. Remember that your balance shouldn’t exceed 30% of your available limit on any given card. So, having fewer cards means the potential to depend too much on one card.
The length of your payment history is another FICO factor. In general, the older, the better, since a longer credit history shows more evidence of responsible spending. If you cancel an older account, you’re lowering the average age of your credit history and increasing your perceived risk to lenders.
Obviously, there are times when canceling credit cards is a good idea, like if you’re consistently overspending and need to eliminate the temptation, or if a card’s high annual fee isn’t justified by its rewards and perks. But consider whether you really need to cancel out a card before you purge your wallet, especially if it’s one of your older cards.
We know how tempting it is to charge purchases worth several thousands of dollars onto your credit card. After all, one of the great things about credit cards is how easy they are to use.
But keep in mind the rule of 30: Credit utilization makes up around 30% of your overall credit score according to FICO, and it’s best to keep your balance below 30% of your card limit. That means that one giant purchase might considerably bump up your balance and your utilization ratio, and lower your credit score. And in addition to the potential hit to your credit score, payments on that big purchase accrue interest from month to month.
Take a second before charging your restaurant’s brand-new $20,000 pizza oven to your credit card. Instead, see if you can take out equipment financing or open a business line of credit that carries a lower interest rate.
→TL;DR: If you pay all your loan bills on time, only open credit lines you know you’ll use, and use those credit cards responsibly, your credit score should be in the clear.
Your credit score is a crucial factor of your small business loan application, because it conveys to lenders how well or poorly you’re able to manage your debt. Plus, most types of business loans have a minimum credit score requirement to be eligible for that loan at all. And then, your credit score guides lenders in determining the rates on that loan. (The higher the better on that front, as is the case with all things credit scores.)
Here’s the main thing to keep in mind: The worst thing you can do to your credit score is not pay your loan bills on time. And the longer that missed deadline passes, the more that delinquency lowers your credit score. So stay on top of your bills and use your credit cards mindfully.
Caroline Goldstein is a contributing writer for Fundera.
Caroline is a freelance writer and editor, specializing in small business and finance. She has covered topics such as lending, credit cards, marketing, and starting a business for Fundera. Her work has appeared in JPMorgan Chase, Prevention, Refinery29, Bustle, Men’s Health, and more.