Managing Your Credit Score
Keeping a keen eye on your credit record can save thousands of dollars… and potential strife in running your business.
A greater understanding of the “secret matrix” behind your credit score has never been more important than in today’s economic environment. It’s probably obvious to you that if you don’t pay your bills on time or a past debt goes to collection, those actions impact your credit score in a negative way. With those unfortunate aspects part of your credit record, it’s likely that you will not qualify for the best rate on a mortgage loan, credit card or auto loan, which will cost you thousands more in interest. But what you may not be aware of is that these days, your credit score could negatively affect several more factors, including your next job opportunity; your auto, home or liability insurance rates; and even your potential security clearance. And these repercussions affect many more people than you might realize.
If you happen to be a business owner, you are already aware of the impact your personal credit can have on successfully obtaining a business line of credit, small business loan or the ability to lease office equipment. A longtime business owner with a track record will have had the time to build up business credit, so the impact of his or her personal credit score is minimized. However, in these economic times, there are many who’ve become self-employed for the very first time in their careers. For these individuals, a personal credit score can be the most important factor in creating a path to business success. New small business owners should be aware that a strong personal credit score, together with a strong business plan, is a one-two punch in obtaining a new line of credit from a bank.
So, what can business owners do to make sure their personal credit record is an asset to help them successfully get access to operating capital and equipment to run an effective business? Let’s peek behind the curtain and learn the secrets of the matrix of a great credit score:
- Payment history—35 percent. The first thing any lender wants to know is whether you've paid past credit accounts on time. This is one of the most important factors in determining your credit score.
- Amounts owed—30 percent. Having credit accounts with a balance does not necessarily suggest you are a high-risk borrower. However, the utilization amount—which is your high credit limit versus your current amount owed—will affect your score. The lower the ratio, the better the score. For example, it’s more favorable to your score to have a credit line with a $5,000 limit and a current average balance of $2,500 than to have an average balance of $4,950. You know who you are. The more available credit to you over a period of time, the better this reflects on your score.
- Length of credit history—15 percent. In general, a longer credit history will increase your credit score. However, even people who haven't been using credit long may have a high score, depending on how the rest of the credit report looks. Credit bureaus assess the length of time that the credit account has been established—including the age of your oldest account, the age of your newest account and an average age of all your accounts—as well as inactivity on certain accounts.
- Types of credit in use—10 percent. The score will consider your mix of credit cards, revolving accounts, installment loans, mortgage loans, etc.
- New credit—10 percent. Research shows that opening several credit accounts in a short period of time represents a greater risk, especially for people who don't have a long credit history.
Managing your personal credit rating responsibly, and doing so long before starting a business, is an immediate necessity. More often than not, a lender will look at the personal credit of the principals of the new business. The philosophy behind this is simple: if those who are running the business have good credit, they will generally be more responsible when it comes to managing the debt of their business. You should also be prepared for lenders who typically require new business owners to personally guarantee the loans for which they apply. When someone signs as a personal guarantor, he or she is backing the loan with personal assets. If the business defaults on the loan, then the personal guarantor is legally responsible for the debt.
Having the necessary elements in place ahead of time can help a business owner qualify for financing at reasonable rates without putting up excessive collateral. You almost have to put yourself in the mindset of the lender and ask, “Would I lend my own money to these individuals, and am I comfortable with the ability they have shown in the past to repay their debt?”
Corporate Veil of Protection
Business owners, without incorporating as a Sub-S corporation, LLC, trust or nonprofit, typically use their personal social security number as a tax ID number, which can significantly complicate a personal credit score. If you can afford it, and your tax advisor recommends it, your personal credit accounts should be kept separate from your business accounts, and you may wish to contact an attorney about incorporating your business and gaining a separate tax ID number. iBi
George DeMare III is managing partner of Midwest Mortgage Capital.