How To Get Small Business Loans If You Have Bad Credit
We’ve been conditioned to believe that a poor credit score is an insurmountable obstacle when applying for small business loans. But contrary to popular belief, having bad credit doesn’t altogether bar you from the capital you need to run your business and grow.
Thanks to the fast-growing alternative lending industry, there are financing options for small business owners with what FICO® defines as a “poor” credit score.
In the content that follows, we’ll cover how lenders assess “fundability,” what financing options are open to business owners with bad credit and what steps they can take to improve their credit score and graduate to more affordable business loan options.
How Lenders Consider Your Credit Score and How That Impacts Loan Options
Before we dive into what are the best bad credit loan options for small business owners, let’s take the time to cover everything credit score—how it’s calculated, categorized and what that means for small business owners in search of financing.
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How Is Your Business Credit Score Calculated?
Your credit score is generated based on the information found inside your credit report. While the makers of the FICO® and VantageScore® score are tight-lipped about their specific calculations, we do know what criteria are taken into account and how that criterion is weighted:
- Your “payment history” holds the most value among the various criteria, at 35 percent.
- The second strongest influence is “amounts owed,” at 30 percent.
- “Account history” carries 15 percent,
- And “new credit” and “types of credit used” each carry a 10 percent value.
The most significant factor, “payment history,” is simply a record of whether you’ve managed to make your payments on time. “Amounts owed” is a bit more complicated as it calculates what percentage of your total available credit is being used, or “utilization ratio” as it’s commonly referred. The less credit you have available, the bigger hit it will have on your score.
“Account history” is determined using the average age of your accounts as well as the last time they were used. Creditors like to see that you’ve been able to maintain several active accounts and continue to use them.
The smallest two categories are how often you are opening new accounts and what type of accounts you are opening. Opening multiple new accounts at once will hurt your credit score, while showing you can manage different types of credit, like a mortgage, car loan and credit card, show responsibility to potential lenders.
What Is Considered a “Bad” Credit Score in the Eyes of Lenders?
Beyond understanding how credit scores are calculated, it’s also important to know how lenders interpret them.
When a lender or creditor runs your credit, they are looking to see which tier your business falls under. This can help them get a better idea of what “type” of applicant you are, what risk they assume if they decide to extend a loan agreement, and based on that risk, how much they are willing to lend, at what rate and term.
FICO® categorizes applicants into five categories based on credit score:
- Excellent: > 800
- While lenders may deny an applicant for other reasons, those with “excellent” credit are rarely denied.
- Very Good: 740-799
- With a credit score falling in this range, you are more likely to be approved for a loan and may even have options to compare.
- Good: 670-739
- “Good” credit gives you a solid chance of being approved, but you probably won’t have the luxury of weighing your options.
- Fair: 580-669
- Consumers with “fair” credit may experience difficulty getting approved for credit and may also experience higher costs.
- Poor: < 580
- A business with a “poor” credit score is often rejected when applying for a loan. Applicants in this range may only qualify for “secured” financing options.
Why Businesses With Bad Credit Are Rejected by Lenders
Credit scores are a measure of a company’s creditworthiness. If a lender determines, from your credit report, that you have been inconsistent with your payments in the past, have too many open accounts or have experienced a previous bankruptcy, they question your company’s ability to repay its loan.
Lenders may also reject new businesses who have yet to create much credit history. If your business is still in its first year of operation or has yet to establish many credit accounts, your best option may be a secured business loan or business credit card.
How to Overcome a “Bad Credit” Designation: What Lenders Also Consider
Many different factors contribute to your “fundability.” Though it’s true that your credit score is a crucial consideration in the business loan application process, other factors come into play, like annual revenue, that can help open up opportunities for funding even with a bad credit score.
1. Annual Revenue
One of the most important parts of your loan application is your business’s annual revenue. A high revenue proves to lenders that you have the capital to repay their loans. When a business owner applies for a loan with bad credit, high annual revenue can help offset the risks tied to that classification. What’s more, your yearly revenue factors into loan size. Generally speaking, the higher the revenue, the higher the loan amount.
Lenders will also want to know if your business is profitable. While your business does not have to be profitable to qualify for a loan, it will help your chances if you are—especially if you’re looking for a business loan for bad credit.
3. Debt Obligations
If you have less than stellar credit, you might have a more difficult time qualifying for a second or third loan product. That’s because many lenders are hesitant to enter into what’s called a “second position” loan agreement. If you already have a business loan, it’s very likely that your lender put a UCC lien on your business. This means that the first-position lender has the right to seize business assets in the event of default first, leaving less collateral (if any) for the second-position lender to leverage to recoup on losses.
4. Cash Flow
A lender’s main concern is if you’ll be able to make their loan payments. Demonstrating that your business keeps enough money on hand to afford regular expenses goes a long way in helping you qualify for financing, especially for a business loan with bad credit. This is why lenders will commonly ask to see at least three months of business bank statements (or more) depending on the kind of financing you’re looking for.
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How to Graduate to More Affordable Loan Options
If you have a bad credit score, you have financing options, though they are limited. There are, however, actions you can take to improve your credit score and graduate to more affordable loan options.
Here’s a quick list of what you can put into practice today to work towards an “excellent” credit designation:
Pay on Time
Delinquent payments and collections can have a major impact on your credit score. Thus, submitting on-time payments is a must if your aim is to improve your current standing. Plus, a history of on-time payment simultaneously builds a relationship with the lenders associated with these accounts. As a result, said lenders might be willing to negotiate terms or extend additional capital to your business.
Boost Your Cash Flow
Cash flow is essential. Lenders want assurances that you have enough cash in the bank to cover all of your debt obligations. For this reason, it’s important to focus on increasing the balance of your bank accounts if your goal is a lower-cost loan with favorable terms.
Monitor Your Credit Score
If you’re working to rebuild your credit, checking your credit score periodically can help you monitor your progress. Use your credit report to review your payment histories and see what you still owe on individual lines. Doing so will allow you to plan accordingly and set realistic goals for yourself.
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Loan Options for Businesses with Bad Credit
As we covered, applicants with a “poor” credit score are considered high-risk by lenders. Still, even with bad credit, there are financing options available. Alternative lenders are less risk-averse than traditional funders, and as such, extend capital to a broader selection of business owners—even those with poor credit. These companies typically focus more on the overall financial health of a business by evaluating the factors we briefly touched on above than a standalone credit score.
5 of the Best Bad Credit Loan Options
As its name suggests, a short-term loan functions as a condensed version of a traditional term loan. Your business will receive a lump sum of cash that it will pay off, plus interest, according to a predetermined payment schedule over a set term. And herein lies the difference: you’ll pay off short-term loans much quicker than a traditional term loan. Generally, short-term loans reach maturity in 18 months or less. And because short-term loans are riskier for lenders, backers may require more frequent payments, on a daily or weekly, rather than a monthly, basis.
A business line of credit provides your company with access to funds to spend as you need them. You withdrawal the exact amount of funds your business needs while only paying interest against the capital you’ve used. You’re never obligated to withdrawal the entire credit line amount.
Invoice financing, also known as invoice discounting, is a type of accounts receivable financing that converts outstanding invoices into immediate cash for your small business. The financing company typically pays you in two installments: an advance of 80-90 percent of your invoice and the remaining 10-20 percent (minus fees) after the invoice is paid in full. Unlike other short-term funding options, the creditworthiness of your business is less of a deciding factor. What’s essential in invoice financing and factoring is the creditworthiness of your customers. As such, invoice financing is a great option for business owners with bad credit.
A business equipment loan allows you to purchase and eventually own equipment for your company in exchange for regular, incremental payments which include both the interest and principal of the loan. You’re able to secure up to 100 percent of the value of the equipment being financed, though some lenders do require a downpayment between 10 and 20 percent.
These loans are typically secured through the equipment being financed. As such your lender will care less about a bad credit score.
An MCA is not a loan, but an advance. When you enter into an agreement with an MCA lender, you receive a sum of cash in exchange for a percentage of your future sales. Unlike other short-term funding options, the creditworthiness of your business holds less clout when determining advance amounts and factor rates. What’s most important in MCA financing is projected sales. As a result, MCAs are a go-to lending product for business owners with bad credit.
How much can my business qualify for?
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How Can I Apply for a Bad Credit Business Loan?
Your credit score is a number used to determine your business’s creditworthiness. But at the end of the day, your credit score is just that—a number. Some lenders value other aspects than just your credit score when determining the health of your business.