Building a good credit score is critical for entrepreneurs and small business owners. At some point you may need to obtain capital from a bank or lender. These banks and lenders may require you to have a good credit score to get approved for financing. If you don’t have a good credit score, getting any type of debt financing for your small business may be difficult. There are alternative financing options for entrepreneurs and small business owners with a bad credit score. However, they are usually only available to established businesses. Entrepreneurs with newly launched small businesses may not qualify for these alternative financing options. This is why building a good credit score is so important. You will have more options to finance your business, whether it’s a startup or established.
The 1st Step is Knowing the Different Types of Credit Scores
There are several different consumer credit score models. Banks and lenders use these consumer credit score models to determine what type of credit risk a borrower will be. Borrowers can be low, moderate or high credit risks. The most popular score model is the FICO credit score. The VantageScore is another score model that more banks and lenders are using. 90% of banks and lenders still use the FICO credit score model. Only 10% of banks and lenders use the VantageScore model. However, it’s still important to know what constitutes a good FICO score and VantageScore. Both the VantageScore and FICO credit score range between 300 and 850, with 300 being the worst and 850 being the best.
The Next Step is Understanding What Constitutes a Good Credit Score
A good FICO score and VantageScore depends on several factors. This includes paying your debts on time, balances you owe towards your debts, age of your credit file, types of credit, new credit, percent of credit limit used, and available credit. To build and maintain a good credit score you should do the following:
- Make timely payments – Paying your bills on time every month has the biggest effect on your credit score. One late monthly payment may cause your credit score to drop significantly. Your good credit score can quickly turn into a bad credit score if you consistently make late payments. A bad payment history will cause you to develop poor credit score. A poor credit score will prevent you from getting any type of financing.
- Minimize your outstanding debt – While having a mix of different credit accounts is good, too much debt can be detrimental to building a good credit score. This can also negatively affect your debt-to-income ratio. Your debt-to-income ratio is your monthly debt payments in comparison to your monthly income. Lenders will use this ratio to determine your ability to manage new debt. If your monthly payment towards your debt greatly exceed your monthly income, you may get denied for new types of financing.
- Keep credit accounts open for a long time – The age of your credit file gives banks and lenders a good idea of how well you manage debt over time. To build a long credit history starting now, get at least one credit card in your name. Use the credit card for small purchases and pay it off every month, on time. You can’t build a good credit score if you don’t open at least one credit account. A credit file with a short credit history doesn’t give banks and lenders much to go on when trying to determine your credit worthiness. You may be denied if you have very little information on your credit report.
- Get loans and credit cards in your name – To build a good credit score, you need to diversify the types of credit accounts you have in your name. A combination of a car loan, credit card and mortgage loan constitutes a good credit mix. For example, when you apply for a mortgage loan, a mortgage lender may look to see if you’ve had an auto loan. An auto loan and a mortgage loan are both term loans. Since they both require a borrower to pay off a certain amount over time (by a certain date), lenders use them to measure how well you manage that type of debt. If you apply for something like an unsecured business credit card, a lender will check your credit report to see how well you manage personal credit cards. This is because a personal credit card and unsecured business credit card is revolving debt. If you made late payments or defaulted on a car loan or a personal credit card, you may get denied for similar types of financing.
- Don’t apply for new loans or credit card debt at the same time – Applying for different types of financing or the same type of financing with different lenders will cause your good credit score to drop. For example, if you apply for five personal credit cards in the same week, with different lenders, your good credit score will drop. It will also create a lot of hard inquiries on your credit report. Hard inquiries are caused by lenders pulling your credit report to check your credit score and history when you apply for any type of financing.
- Keep your credit card debt low – High credit utilization will cause your good credit score to drop. High credit utilization is using almost all of your total available credit limit. A high credit utilization rate is anything over 30%. For example, if you have a personal credit card with a limit of $6,000, you should use no more than $1,800 of it. Lenders see credit cards as maxed out once you reach 30% credit utilization. This is because history has proven that borrowers with a credit utilization rate over 30% have a greater chance of defaulting on their credit card debt.
Building a Good Credit Score Takes Time, One Mistake Can Ruin It
Building a good credit score and history takes time. There is no way to cheat the credit scoring system no matter what anyone tells you. That’s why once you build a good credit score, you have to do everything in your power to keep it. One mistake, like a late payment, can cause your good credit score to drop. Lenders will take that one late payment into account when you apply for financing. Most lenders don’t want you to have any late payments in the last 2 to 3 years when you apply for financing.
Check Your Own Credit Report Before You Apply for Any Type of Financing
You can pull your own credit report to check if you have a good FICO score or VantageScore. There are many free credit report and free credit score sites online. However, they are not always accurate or provide the detailed information you need to analyze your credit rating. The best free credit report and free credit score site for entrepreneurs and small business owners is NAV. NAV provides entrepreneurs and small business owners with their FICO score and VantageScore, as well as their business credit scores. I always suggest entrepreneurs and small business owners use NAV because it is the ONLY site only that will provide you with free access to your personal and business credit information.
NAV also offers paid plans for entrepreneurs and small business owners who want to see more information than what is in their free plan. Their best paid plan is $29.99 per month and is designed specifically for entrepreneurs and small business owners that plan on applying for financing in the next six months. A credit report from NAV will help you thoroughly analyze your credit history and prepare to build a good credit score so you can qualify for small business financing.