With an estimated 99.95 percent of small business owners and entrepreneurs opting for debt financing, knowing how to prepare your business for a loan application is a must.
Among the documents that a lender will review, your personal credit as well as your business credit are criteria that play an important role'”both can either assist, or in some cases obstruct, your ability to secure financing.
Let's review some key strategies that everyone needs to know about personal credit score vs business credit score.
Personal Credit Score vs Business Credit Score, What’s the Difference?
These two scores are often independent of each other and they measure different things. Your personal credit score measures your creditworthiness'”your personal ability to pay back a debt. On the other hand, a business credit score measures the ability of your business to meet its own financial obligations. Let's take a look at each one in a bit more detail.
What It Is
Your personal credit score helps a lender evaluate whether or not to offer you credit, how much to lend you, and what terms (e.g. APR, requirement of collateral) to use. While different personal credit scores have different ranges, one thing never changes: the higher the score, the more financially trustworthy a borrower is considered to be.
Who and What Determines Your Personal Credit Score
Using your Social Security Number (SSN) and your credit history, the three credit reporting bureaus (Equifax, Experian, and Transunion) assign your creditworthiness a score, all using variations of the FICO Score algorithm.
Ranging from 300 to 850, the FICO personal credit score is made of five key components:
- Payment history (35%): The most important factor in a FICO score is your payment history to lenders. Your ability to pay on time is the first thing that lenders take a look at.
- Amounts owed (30%): The whole point of seeking a high credit score is to be able to borrow money when you need to. Owing money doesn't necessarily make you a high-risk borrower but maxing out your credit cards and carrying a high balance on them for several months will negatively affect your FICO score.
- Length of credit history (15%): It takes time to build a good credit score. In general, the longer a credit history, the higher a FICO credit score.
- Credit mix (10%): There are different types of debt, including retail cards, credit cards, car loans, and more. Without some form of debt, FICO can't determine your score. So, you need to responsible use credit cards and installment loans to start (and build up!) your score.
- New credit (10%): FICO believes that opening several new credit accounts within a short period of time increases your credit risk.
Tips to Boost Your Personal Credit Score
- Automate your credit payments. Since paying your lenders on time represents 35% of your FICO score, sign up for automatic payments for all of your credit accounts. Most lenders allow you to set up auto payment using your bank's routing number and account numbers. Another option is to schedule payments using the bill payment service from your bank or a third-party payment processor, such as Mint.com or MyCheckFree.com.
- Adjust your due dates. You don't have to settle for a due date that is poorly timed with your paycheck. Except for those of mortgages, most due dates can be adjusted with a quick phone call. Depending on your lender, the change may take two to three bill periods to take effect.
- Aim for a credit utilization ratio of 30%. Whenever you can, pay off your credit cards in full month after month. If that's not possible, then aim to have a balance of no more than 30% than your credit limit for each card. A credit utilization ratio of under 30% across all cards is a sign for lenders that you're managing your credit responsibly.
- Handle new credit carefully. Chasing too many of those deep discounts for opening store cards will eventually catch up with you. Every time that you open a new account, your FICO score takes a small hit. So, open a new card only when you really need to.
- Don't close oldest accounts. The number of years that you have held each one of your cards and debts affects your length of credit history. By closing your oldest account, you may dramatically reduce your length of credit history and negatively affect personal credit score.
- Order your free credit report every 12 months. FICO and all lenders use your credit history to determine your creditworthiness, so making sure that your credit report is accurate is a must. Every 12 months, request your credit report. Verify that all you personal data, including SSN and mailing address, and listed accounts are correct. To dispute any inconsistencies, follow the instructions on your credit report or file a dispute online with Equifax, Experian, or TransUnion.
What It Is
Also known as a trade or commercial credit score, your business credit score helps financial institutions to determine whether or not you're a good candidate for debt financing. A high business credit score can improve your chances of obtaining a business loan'”and likely, you'll be able to receive much more favorable terms. Alternatively, a low score can mean higher interest rates, and in some cases, even prevent you from being eligible to borrow.
Additionally, vendors and suppliers often check your business credit score when considering whether to invoice your business on a Net 30 or Net 60 basis.
Who and What Determines Your Business Credit Score
Just like a SSN for individuals, an Employer Identification Number (EIN) allows the IRS and the credit reporting bureaus to track businesses. If your small business is incorporated and has an EIN, registering it with Equifax, Experian, or Dun & Bradstreet is the first step to establish your business credit score.