Key Takeaway Table
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Understanding Credit Scores
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A credit score is a numerical value that represents the creditworthiness of a business or individual. Several factors can determine your credit score, including credit history, amount of debt, and repayment history. A higher score is more attractive to lenders because it demonstrates that a business is lower risk. On the other hand, a low credit score can raise red flags about a borrower’s capacity to repay loans or the likelihood of non-payment.
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Business Credit Score vs. Personal Credit Score
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A business credit score is for businesses and companies and can be determined by the enterprise's payment history, credit utilisation, industry risk, and more. It can influence the business's ability to secure funding. Meanwhile, a personal credit score evaluates an individual's creditworthiness and can determine their ability to borrow for both personal and business purposes. In most cases, both business and personal credit scores will be examined by lenders to determine creditworthiness.
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Impacts of Credit Scores on Business Loans
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Business credit scores can impact whether a business can receive a loan approval. They can also determine the loan terms, such as interest rates and the loan duration. Business credit scores can also limit your selection of lenders and can impact which loan types are available to you.
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When you’re applying for a business loan, the first thing you want to prove to lenders is your capacity to repay the loan you’re applying for. Lenders can gauge this through your business income and cash flow and also through your credit score. Your credit score demonstrates your creditworthiness, showing lenders your behaviour when it comes to repaying and managing debts. Let’s look at what makes up your business’s credit score and how it affects your eligibility for business loans.
Understanding Credit Scores
A credit score, like those provided by Equifax, is a numerical expression that represents the creditworthiness of a business or an individual. Lenders use this score to evaluate the potential risk of lending money to minimise bad debts. Credit scores help lenders decide who qualifies for a loan, at what interest rate, and what credit limits.
In Australia, credit scores are calculated by credit reporting agencies like Equifax and Experian. These scores range typically from 0 to 1,200 or 0 to 1,000 depending on the credit reporting agency. Typically, a score of 600 and above is ideal, and anything lower can be a red flag for lenders, especially banks. The score is determined by several factors, including your credit history, the number of credit accounts you have open, the amount of debt you have, and your repayment history.
A higher score indicates lower risk to lenders, often resulting in more favourable lending terms such as lower interest rates or higher loan amounts. Conversely, a lower score can make it harder to obtain loans and may lead to less favourable terms.
Credit scores are dynamic and can change over time based on your financial behaviour. If your credit score is low now, you can take steps to improve it and improve your chances of getting a business loan. Your score can also decrease if you don’t ensure that you’re managing your debts properly.
Business Credit Score vs. Personal Credit Score
Business and personal credit scores serve as a metric for creditworthiness but cater to different entities: one for individuals and the other for businesses. However, in most instances (private lending an exception), both scores are crucial to business loan approval. Here are their key differences:
Business Credit Score
- What’s Being Assessed: A business’s or company’s creditworthiness.
- Purpose: Used by lenders to evaluate the risk of lending money to a business. Suppliers and potential business partners may also use it to assess the risk of doing business with a company.
- What Factors Influence the Score: Business’s payment history to suppliers and lenders, credit utilisation, company size, industry risk, and length of credit history. Public records such as liens and insolvency can also affect a business’s credit score.
- Impact: Influences a business’s ability to secure financing and trade credit. It also influences the overall financial reputation of the business, affecting which suppliers and businesses want to do business with you.
Personal Credit Score
- What’s Being Assessed: An individual’s creditworthiness.
- How It’s Used: Used by lenders to evaluate the risk of lending money to an individual for business and personal financing needs.
- What Factors Influence the Score: Payment history, credit utilisation, length of credit history, types of credit in use, and new credit accounts.
- Impact: Affects an individual’s ability to borrow money and the terms like interest rates and the loan duration.
Impacts of Credit Scores on Business Loans
Impact on Loan Approval
A director’s credit score is often the first factor lenders consider when reviewing loan applications. A high credit score can significantly increase a business’s chances of being approved for a loan. A higher score indicates lower risk, demonstrating the director has a history of repaying debt on time. A low credit score can lead to unfavourable loan terms, and in some cases, applications being declined.
Influence on Loan Terms
Directors with higher credit scores usually qualify for loans with more lenders, which leads to lower interest rates. On the other hand, a lower credit score might result in fewer lender opportunities, meaning higher interest rates and an increase in the cost of borrowing. A strong credit score can also influence the amount of money a business is eligible to borrow. Lenders are more likely to offer larger loans with longer terms to businesses with proven track records of financial responsibility. Favourable repayment terms, including longer repayment periods and more flexible payment schedules, are also available to directors with higher credit scores.
Impact on Lender Selection
Your business’s credit score can affect which lenders you can successfully approach for business loans. For instance, traditional bank loans, which generally offer better terms, might require higher credit scores. Directors with lower scores may need to consider alternative financing options, which usually have higher interest rates and shorter terms.
Impact on Loan Types Available
Your credit score can also determine the types of loans you are eligible for. If you have a higher credit score, you may be eligible for a wider array of loan products. However, if your score is low, there are still many unsecured and secured loan options. Secured loans will typically have lower rates as the security can help mitigate risk for lenders.
Improving Credit Scores for Better Loans
Here are some steps you can take to improve your credit score in preparation for loan applications:
- Pay back debts on time.
- Ensure that you make payments on your debts on or before their due dates. Late payments can negatively affect your credit score. Setting up automatic payments for recurring payments can help you avoid late payments.
- Regularly check credit reports.
- Obtain credit reports from major business credit bureaus. Review these reports for errors or inaccuracies that could be hurting your score and dispute any errors you find.
- Limit credit inquiries.
- When you apply for a new credit card or loan, a hard inquiry is made on your credit report, which can temporarily lower your score. Limit the number of new credit applications to avoid too many hard inquiries.
- Monitor Your debt levels.
- Keep your debt at manageable levels to ensure you can make regular payments.
Find the Best Rates and Terms No Matter Your Credit Score
We are loan experts who can help you find the best loans fit for your credit score. Whether your score is high or less than ideal, we can steer you in the right direction so you can get lower rates and better terms overall.
