It’s Not Personal, It’s Business

You know that you need a good personal credit record to qualify for purchases and transactions in your private life, such as getting a mortgage, renting an apartment or even getting a cell phone plan. But you may not be aware of how important a business owner’s personal credit history is for running a business. Your personal credit history will determine the types of credit lines, business loans, credit cards and even the rates for which you may qualify.

Businesses build a credit record, just as individuals do. However most small businesses can’t get a line of credit without a personal guarantee for the loan from the owner(s). For one thing, businesses such as sole proprietorships, general partnerships and limited partnerships aren’t considered separate from the business owner.

The business may have established a taxpayer ID number, but it is the business owner’s personal Social Security number and credit that is evaluated for business credit. It’s not just those particular business structures that have difficulty; personal guarantees are routinely required from the owners of corporations until those corporations reach a certain level of annual sales — a level that could reach into the tens of millions.

Banks and lenders are not the only ones to look at an entrepreneur’s personal credit. The insurance industry may also use insurance bureau scores, based on consumer credit reports, along with pertinent information to evaluate applications and determine rates. According to Amelia Lobo, an underwriter with ACCION, a New York organization that provides microloans and business advisory services to small businesses, this is common practice.

And, just as with personal leases, commercial landlords may use either a credit bureau report or a combination of tenant or reference checking services specific to the industry to evaluate a lease application. You could be denied a lease for your business based on your personal credit. (According to the Fair Credit Reporting Act, if you are denied credit the creditor is required to provide you with the name and contact information of the credit bureau used. You can request a free copy of the report within 60 days.)

So it’s crucial to understand what goes into your credit score and report, how it’s used, and how to keep your record clean and your score high enough to get favorable lending terms.

How Credit Bureaus and Credit Scores Work

A credit score is a number — typically between 350 to 850 — that indicates your creditworthiness to lenders. The three major credit bureaus, Equifax, Experian and TransUnion, all use a formula based on the Fair Isaac Corporation (FICO) model to calculate your credit score.

Five categories of information make up a credit score, including your payment history, the amount you already owe, the length of your history, how much new credit you have and the types of credit that you use. (See graphic on page 36 for how the information
is weighted in your score.) FICO scores above 700 are categorized as good by many lenders, but this, of course, varies and there is no universal minimum score.

Recently the major credit bureaus created a new credit scoring system called Vantagescore to compete with FICO. A Vantagescore ranges from 501 to 990 and includes a letter grade. More weight is placed on payment history (32%) and negative balances (15%), for a 47% total, versus FICO’s 35% for payment history (includes negative balances).

Tips for Building and Maintaining Good Credit

There’s no mystery to how to maintain good credit. You need to organize your finances, pay all bills on time, and watch your credit card balances and keep them low. When possible repay your balance in full at the end of the month and never use more than 30% to 50% of your limit.

Applying for credit is tricky, since an application creates an “inquiry” of your record. You should apply only when you need credit. Too many credit applications affect your score.

It’s also important to periodically request a free copy of your report to monitor mistakes and identity theft. A 1998 U.S. Public Interest Research Group study showed that 70% of credit reports had some type of error, while 29% contained major inaccuracies (false judgments or delinquency notices). Errors can result in denied loans and higher interest rates, key for small businesses. Everyone is entitled to a free copy of their credit report every 12 months from each of the three bureaus. (Go to: www.annualcreditreport.comor call 1-(877)-322-8228. The free report does not include your score but gives you the option to purchase it for $6–$8.)

If you are planning on applying for a line of credit or a loan, purchase your score and review your report before applying, so you have a chance to correct any errors in the report.

Personal credit versus business credit

Business credit looks at some of the same factors as personal credit, but there are differences. For example, payment data may be collected from company suppliers, and liens and legal judgments are often compiled from various courthouses.