Credit score plays a crucial role in determining loan eligibility in many cases. Borrowers with higher credit scores can get hassle-free loan approvals, considering their creditworthiness. A timely repayment, avoiding maxing out credit limits, monitoring credit reports , etc., helps maintain a higher credit score.
However, credit scores are of two types: Personal and Business credit scores. Generally, lenders verify your business credit score while approving a business loan. You might think a personal loan has nothing to do with your business loan approvals, but that’s not true. Read this blog to learn how your business loan eligibility depends on your personal credit score as well!
Why is a Personal Credit Score Important for Availing a Business Loan?
As a business owner, you might assume that your business identity differs from your personal identity. Technically, your personal credit score should not affect business loan applications. It is the business credit score that should be looked into while borrowing a business loan.
However, being the sole responsible person (or one of the key members in case of a partnership) behind the business, your personal credit score does matter to the lenders. They will assess your personal credit and repayment history before sanctioning a loan for your business.
This applies to small business firms as they do not have any previous relationship with the financial institution. Being new to the market, your organisation may not have any credit profile. In such cases, the lender considers your credit history to sanction a loan for your business. As small businesses do not have clear financial information, lenders need to inspect the owners’ personal credit scores to take approval decisions. Therefore, your personal credit score matters in availing of a business loan for your organisation.
How does Your Business Type Determine the Importance of Personal Credit Score while availing business loan?
Businesses differ from each other in terms of structure and function. While availing of a business loan, the business type plays a crucial role in determining the importance of your personal credit history. So, here are some of the vital business types to consider:
- Private or Public Limited Company
A private or public limited company holds a separate legal authority as its operation area is more prominent than other businesses. These are large-scale businesses that have been running for long years. Over the years, they have built relationships with multiple banks or financial institutions.
Therefore, these companies have their business credit score and corporate identity. Considering their present financial positions and company goodwill, lenders do not ask for the founders’ personal credit score while sanctioning loans. However, under certain circumstances, the business owner’s or directors’ personal credit score can be taken into consideration.
- Sole Proprietorship
A sole proprietorship business, as the name suggests, is run under the ownership of an individual. In such businesses, the sole proprietor or the owner is the company’s representative. If you run such an organisation, you are the sole authority and responsible person to borrow and repay the business loan.
As per law, you are liable for the company’s debts and credits. So, lenders will check your credit score before sanctioning your business loan.
- Partnership Firms
Business loan approval for partnership firms works in the same way as sole proprietorship businesses. All the partners involved in a partnership business must produce their credit score and other documents while applying for a loan. Lenders will enquire about the credit history of the partners involved in the business and sanction business loans accordingly.
What is an Ideal Credit Score to Apply for Business Loans?
Business loans are of two types: secured and unsecured. In the case of secured loans, you need to pledge collateral to borrow the money. Thus, you can also avail of such business loans with a low credit score. Borrowers with a credit score between 600 and 700 are eligible for secured business loans. However, you require a higher credit score for unsecured business loans, as they are not collateralized loans. Generally, you need a credit score above 700 to avail unsecured business loans.
Apart from personal credit scores, lenders also enquire about the business credit score in case of a partnership, public, and private Ltd. companies. Thus, you should hold a decent business credit score to avail of business loans.
How Does Business Loan Type Determine the Importance of Your Personal Credit Score while availing business loan?
The type of loan you are taking also plays a significant role in deciding the importance of your personal credit score. Here are some of the different types of business loans and the importance of personal credit score to avail of them:
- Equipment Financing
Equipment financing loans are secured loans as you need to pledge the purchased equipment as collateral. If you borrow such a loan to upgrade your company’s machinery or equipment, personal credit score should not be a concern.
- Long and Short-term Loans
A long-term unsecured loan is a riskier factor for lending institutions as these are not collateralised. Thus, you need to have a strong business credit score and reputation. If the lender cannot rely on your business information, it will verify your personal credit score before approving the loan. The same goes for short-term loans as well.
- Invoice Factoring
You can borrow an invoice factoring loan by pledging the receivable accounts as collateral. Thus, the personal credit score no longer matters when your asset already backs up the credit.
What are the Ways to Ensure a Good Credit Score?
So far, it is clear that your credit score plays a significant role in determining your business loan eligibility. Hence, you need to maintain a high score to finance your business hassle-free. Here are some tips to ensure a higher credit score:
- Avoid Loans that You Cannot Afford
While availing any loan you should always consider your income and expenses. It will help you frame a planned repayment structure for the availed loan. If the EMI amount exceeds your monthly net income, it is better to avoid such loans. This is because you will face difficulties while repaying it. Consequently, it will affect your credit score.
- Pay Your EMIs on Time
Paying out your EMIs timely or before the due date helps increase your creditworthiness. If the repayments remain pending or get delayed, it will affect your credit score adversely. Thus, always pay your debts on time to maintain a higher credit score.
- Do Not Borrow Unnecessary Loans
You should always borrow loans on purpose. Availing too many loans without any proper intent can affect your creditworthiness as you may fail to repay them on time. Moreover, if you have already applied for too many loans, it will also affect your credit score adversely.
Thus, your credit score affects personal loans and plays a significant role in sanctioning business loans. Your creditworthiness helps the lender assess your company’s repayment capability.
Q1. What are the benefits of maintaining a higher credit score?
Ans. A higher credit score represents your creditworthiness. Thus, lenders may approve your loan application when your credit score is high. Moreover, it helps build a credible relationship with the lender, to acquire attractive interest rates.
Q2. Can I apply for a business loan with a credit score below 650?
Ans. If you have a credit score between 600 and 650, it may be difficult to borrow loans. However, you can avail of secured loans with low credit scores as you are backing up the credit with collateral.
Q3. What are the ways to assess a credit score?
Ans. Your credit score is assessed in the following ways:
- Credit Enquiries
- Repayment History
- New Credits
- Credit Line Duration
Q4. What are the factors that adversely affect my credit score?
Ans. Here are some of the factors that can affect your credit score negatively:
- Unpaid debts
- Poor repayment history
- A higher credit utilisation ratio
- Error in credit reports
Krishna is an investment professional with a demonstrated history of working in Debt Capital Markets. He has completed his B.E. (Hons) in Computer Science Engineering from BITS Pilani and MBA (Finance) from JBIMS, Mumbai. He is currently working as Investments Principal at Wint Wealth. Previously he worked at Kotak Mahindra Bank at their DCM desk and Northern Arc Capital at their Structured Finance desk.