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You might be aware that the debt you currently have can impact any business loans you’re looking to take on… But did you know that the kind of debt matters, too? Here’s the lowdown on how the type of debt you have affects your business loan chances.
Many small businesses lack a substantial enough business credit history for lenders to consider, so they instead look at personal credit to check your history of making payments on time—as reflected in your credit score. They might also take a look at your debt service coverage ratios, which represent your total current debt to your total current income.
Like with many homeowners, your mortgage might be your biggest monthly debt payment. If it’s high compared to your income, that mortgage can impact your ability to get a loan—it might make your lenders feel that your debt service ratios are too large for you to take on additional debt.
A lender looking for collateral might also be interested in the equity you have in your home, which is the difference between your home’s current market value and the outstanding mortgage amount. If you have a large mortgage with little equity, there might not be room for a second mortgage to secure a business loan.
Your student loan debt could have a significant effect on getting a business loan, according to recent research by Penn State’s Smeal College of Business and the Federal Reserve Bank of Philadelphia. The report, The Impact of Student Loan Debt on Small Business Formation, found that some would-be small business owners were so burdened with student loan debt that lenders didn’t want to lend them more money.
This is particularly true for the smallest of the small businesses, which would need to rely on personal credit information to get startup financing. If you’re looking for a business loan but your student loan payments push your total debt service ratio up, you might be better served looking at alternative lending options.
According to credit reporting agency Experian, while your business and personal credit reports aren’t linked, they might be related if you use personal collateral (like a home) to secure your business debt—a common practice for sole practitioners and solopreneurs. Experian also says that half of all small businesses use some form of personal credit to finance their businesses.
If you have personal loans like a signature loan or a secured car loan, a business lender might look at how the loan has been repaid. For example, are you making your personal loan payments in full and on time, every time? They would use your past habits to try predicting how you might behave if they gave you a business loan on top of your other debt.
Unlike mortgages and student loans—which have fixed terms, interest rates, and monthly repayment amounts—credit cards and credit lines are revolving credit with a set limit. Traditional business lenders assessing your personal credit are often interested in your revolving credit, because as long as the account is in good standing, each time you pay down the balance you can always borrow again up to the set limit.
Lenders will take a look at what your total debt service ratios would be if you maxed out all of your credit cards and lines of credit—even if you currently have a zero balance—and evaluate whether your income could support their monthly business loan payment in addition to the payments you’d have to make on your maxed out revolving credit. In other words, a lender will imagine the hypothetical scenario in which you’ve exhausted all of your lines of credit and have their loan to deal with, too.
Note: This is also the case if you already have a business credit line in place and are applying for a new business loan.
Do you already have a business loan? Have you been careful about keeping up with payments and following the terms and conditions of the loan? And did your lender report this responsible borrowing behavior to the business credit bureau? If so, having one business loan under your belt could actually improve your chances of getting another, especially if you’re looking to consolidate your current loan into a larger one.
If your business has successfully borrowed money—and paid it back, or is in the process of doing so—with a startup loan, equipment financing, short-term loan, or even a business credit line or a business credit card, you might have a shot at getting a traditional or alternative financing business loan. And if your business has been operating for a while, has a business credit history, and maintains a record of strong revenue, you could even qualify for better terms and rates than you did for your first loan.
While your outstanding debt or poor credit record might leave you feeling discouraged about your chances of qualifying for a new business loan, don’t give up just yet. Take a look at alternative funding sources, like invoice financing if you have strong credit card receivables or asset-based loans if your business enjoys steady cash flow. And remember, do your research, compare business loan offers, and ask questions before signing on the dotted line.