Let’s face it. Bad credit happens to the best of us. Whether you’re saddled by a costly hardship in your life or are just bad at paying credit card payments on time, you aren’t alone. In fact, 56% of consumers have subprime credit scores, according to a report from the Corporation for Enterprise Development (CFED).
For many people, taking the time needed to build your credit back up after a financial falling out is no big deal. But if you plan to start a company or want to build your small business with a capital investment, lack of money and/or bad credit can put a wrench in your plans. Although it may look bleak, it’s not impossible to secure a loan and get your business back on track.
Bad credit is generally defined as a credit score between 300 and 629. It’s broken down like this:
- 800 plus is an excellent rating: You have no late payments or collections on your credit report. You have a long history with the credit rating bureaus and will likely qualify for the lowest rates at any financial institution.
- 750-800 is a very good rating: You have no late payments or collections on your credit report. You likely have a shorter history with the rating bureaus, but will also likely qualify for the lowest rates at any financial institution.
- 700-750 is a good rating: You don’t have any recent late payments or collections on your report. You should be able to get a pretty good rate at any lender.
- 650-700 is a fair rating: This means you likely have some recent late payments or collections, but not currently. You still should be able to get a pretty good rate at just about any lender.
- 600-650 is a bad rating: This means you are struggling with collections at this point and have also struggled in the past. Because of your credit rating, you are likely going to have to pay a higher interest rate, but there are some lenders that will offer better rates than others.
- Below 600 is a very bad rating: You are in the middle of collections now and have struggled in the past. You will pay a high rate for credit because of your rating.
If you credit score falls in those last two brackets, you should focus on repairing your rates. But in the meantime, you still need financing to grow your business. It’s going to be nearly impossible to get bank financing with a low score. When ascertaining risk for a loan, banks look at the credit history of the primary applicant more so than the profitability of the business. This means thateven if your business is profitable, a black mark on your personal credit history will overshadow that. This can even include small blemishes such as late mortgage or credit card payments.
But don’t give up just yet. First of all, it’s never a bad idea to at least apply for a traditional bank loan. Under federal consumer protection laws, banks are not allowed to automatically deny people loans without reviewing the total picture of their financial situation first. This means taking a peek at your income, your business’ past few years of earning history, and your forward-looking business plan to show how you’re going to use the business loan to make more money in the future.
If you still can’t secure a bank loan, there are other ways to fund a business or capital expense. According to the Bank for International Settlements cited in CNBC, the size of the non-bank financial system in the U.S. has grown to $3.2 trillion. These alternative business lenders have become a more important source of loans and financing for small businesses. Alternative business lenders provide options for bad credit borrowers as they place more of an emphasis on the strength and operating history of your business. As with any small business loan, it’s important to carefully compare all your options, weighing each loan’s terms and APR.
If you only need a small amount of capital, a microlender might be a good place to start. These nonprofit institutions specialize in offering small-balance loans to startups. According to CNN Money, microlenders provide one-on-one assistance and training for small businesses, in addition to loans.
Asheesh Advani, CEO of Covestor, an online marketplace for investors, notes that www.microenterpriseworks.org is a good website to check out to search for local nonprofit organizations in your area that have programs for business owners with poor credit.
“Most states now have at least one microlender,” Advani says. “For some business owners, flexibility of repayment is more important than getting a slightly lower rate.”
ALTERNATIVE BUSINESS LOANS
Alternative business lenders are also a worthwhile option if you need a larger amount of credit than a microloan can provide. You should have a solid, healthy business plan and show you are working toward fixing your credit. An influx of future capital wouldn’t hurt either.
Because there are a ton of online and alternative lenders to choose from, it’s important to shop around, compare rates, and always call and speak to a trusted lender rather than blindly applying for business loans online. Each lender offers a twist on how they price business loans and spread risk to their lenders/investors, so it’s a critical first step to check out ratings with the Better Business Bureau and customer reviews on sites like www.trustpilot.com. Some lenders may have steep interest rates, a mandatory down payment, or an alternate length of the bad credit business loan. Also, the amount of the bad credit business loan is typically less than a regular loan awarded to a company with a strong credit history.
Conversely, some lenders offer partial payments and more flexible terms, which will help you keep on track with payments. They will also often report your payments to credit bureaus, and in the end, this can help you raise your credit score – as long as you pay on time.
At United Capital Source, business loan programs are performance driven and to qualify, UCS loan managers weigh the last three months of bank statements more heavily rather than personal credit history of the business owner. They also have designed programs specifically for small-to mid-sized business and for those with bad credit. Because they also invest in the actual loans along with their network of business lending partners, they are able to offer longer loan terms and cheaper rates.
PRIVATE BUSINESS LENDERS
If you strike out with banks and alternative business lenders, another viable option may be to seek help from relatives and friends. Since these folks are closest to you, they want you to succeed. “The average rate on business loans from relatives and friends is currently at 7.6%, according to CircleLending’s Business Private Loan Index,” says Advani.
If you have a family member or friend who has the means to offer you a business loan, you can use a loan management company to service the loan and report payments to credit bureaus. This way, you are still rebuilding your credit score while you repay your Uncle Bob or university buddy.
If none of these options are viable or fit within your business plan, there are a few other avenues to try, according to Angelique O’Rourke of Palo Alto Software:
Merchant cash advance or business cash advance: This option is only applicable to those with cash flow problems who would need $5,000 or more. Merchant cash advances usually have high factor rates as well. This means you will almost certainly pay more in the long run than with a traditional loan. If you go this route, at least your payments will be flexible because payments are made by taking a daily percentage of sales that won’t kill your cash flow.
Business credit card: As long as you can secure a credit card in your company name and make purchases and on-time payments, you can get financing and start building good business credit at the same time. “Of course, the credit limit, interest rate, and terms of payment will vary, and each bank or credit union will have eligibility requirements, so this option will not work for everyone,” adds O’Rourke.
Home equity line of credit: Take a deep breath and think about this one before pulling the trigger. This option only applies to those who own homes, and it’s extremely high-risk. You put up your house as collateral to secure a bank loan, so if you can’t pay you could lose your business and your home.
Revenue-based loan: This is a niche type of option, and you must have a credit score of over 500 to apply. Your company also must make more than a $100,000 a year in sales, and the loan amount cannot exceed 10% of your revenue. You can receive this type of loan in as little as a week’s time.
IMPROVE YOUR SCORE
Now that you are well on your way to funding your business needs despite your bad credit, it’s time to take steps to improve that rating. It’s a good idea to start now, even if your initial steps are small. The first thing you should do is check your credit report. Make sure all the information is correct.
“Bankruptcies over 10 years or the associated accounts shouldn’t be reflected on the report,” offers Forbes contributor Ty Kiisel. “Other negative information older than seven years should not be on the report either.”
He offers the following tips to get you started on your path to healthier credit:
- Get a major credit card and arrange automatic payments for your credit cards and loan payments. Using a major credit card such as MasterCard, VISA, Discover, or American Express will help you build credit as long as you use it wisely. Credit scores are very sensitive to whether or not you make payments on time, so automatic payments will ensure you don’t forget to pay. Some credit card companies allow you to set your own monthly payment, rather than just the minimum due. This way you don’t have to sacrifice substantial payments for automation.
- Avoid collections at all costs. If you have a dispute with a vendor it’s better to pay under protest and go to small claims court than let the dispute go to collections. Just be sure you don’t put yourself in a position to get sued. Lawsuits and judgments are also major black marks on to your credit.
- Consolidate your debt if you can’t pay it off quickly. The scoring criteria treats installment loan balances kinder than the same balances on a credit card.
- Don’t close accounts or let them be closed. It might not help your scores and could hurt them, Kiisel warns. If you’ve got a card you haven’t used for a while, take it out to dinner or buy a tank of gas, just make sure they’re included with your other automatic payments.
- Don’t apply for credit you don’t need. At about 5 points an application, if you have sketchy credit, it can add up.
There are not only many options for securing funding with bad credit, but there are equal possibilities for repairing the damage. Even if you are among the majority of consumers weighed down by bad credit, there are ways to dig yourself out of that hole and maintain your business as you go.