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Low Credit Score Could Keep You From Owning a Small Business

June 2, 2015
Credit Score
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A good credit score is important for getting a mortgage, setting up utilities and obtaining insurance at decent rates. But you may be overlooking a very important reason to have excellent credit — it can help you fulfill your dream of opening a business.

When you’re opening a new business, good personal credit is critical to securing financing. A new business doesn’t have a credit history of its own, so lenders may be wary. And while a decent personal credit could help you get funding, it likely won’t have the best terms, which could cost you thousands of dollars over the life of the loan.

Say you’re taking out a $50,000 small-business term loan. At some community banks, interest rates can be as low as 3.5% to 6.5%, but still, the difference in cost is notable. Here’s what the difference looks like for a five-year loan:

Interest Rate Monthly Payment Total Interest Paid
3.5% $910 $4,575
4.5% $932 $5,929
5.5% $955 $7,303
6.5% $978 $8,698

In this case, a difference in credit could cost more than $4,000. As new businesses typically don’t turn a profit for the first year of operation, you likely could find a better use for that cash than interest payments.

How to improve your credit for a small-business loan

To get approved for a small-business loan at favorable terms, you should aim to improve your credit in a few ways.

Pay your bills on time.

It sounds obvious, but this is the most important thing you can do to improve your credit. Reported late payments remain on your credit report for seven years and typically result in late payment fees. To avoid this consequence, set up automatic payments for all of your accounts or create email or text reminders for your due dates.

Pay down your existing debt.

The second most important factor that determines your credit score is credit utilization, or the ratio between your debt balances and credit limits. We recommend keeping this below 30% at all times — though lower is better — as balances are often reported mid-billing cycle. If you currently carry a high balance, create a plan to get your utilization down to a safe level.

Avoid applying for other loans or credit cards.

Refrain from opening new lines of credit until you successfully obtain your small business loan. Each new loan application results in a hard inquiry and shortens average length of your credit history, both of which can damage your credit score.

Peruse your credit reports for errors.

An error on your credit report could be hurting your credit score, even if you always practice good credit habits. To prevent this, pull your credit reports — it’s free once a year — and check for errors. If you find any discrepancies, dispute them right away.

Be patient.

If possible, hold off on applying for a business loan until your credit score is in the excellent range. Provided you’re doing everything right, it takes time to get your score from “meh” to marvelous. And a few percentage points’ difference in your interest rate could translate to thousands of dollars saved.

Erin El Issa is a staff writer covering personal finance for NerdWallet. Follow her on Twitter @Erin_Lindsay17 and on Google+.

Image via iStock.