For most small businesses it is nearly impossible to get financing based purely on the financial performance of the business. The business owner’s personal credit history and credit score are important factors in obtaining a loan or line of credit and setting the interest rate that will be charged. Therefore, it is beneficial for entrepreneurs to understand their personal credit, how it got that way, and how to manage it.
In the 1980s the three major credit bureaus, Experian, TransUnion, and Equifax worked with the Fair Isaac Company (FICO) to create a unified system to track, report, and score the credit experiences of consumers. They developed algorithms that calculated a number of factors, including payment history, amount, type and length of outstanding debt, and the number and types of credit inquiries. On a scale of 300 to 850, this FICO Score became the industry standard for a snapshot of an individual’s credit worthiness.
Initially the scoring was fairly secretive. Scores were available to lenders but consumers were unable to see their own scores and were also in the dark about what constituted a “good” score. In 2001, under pressure from consumer groups and Congress, Fair Isaac agreed to release the scores to the general public and explain how they are derived. Now it is very easy to track personal credit reports and scores, and this has become another income stream for Fair Isaac. As anyone who has requested a score knows, there is almost always a cost to receive a score.
So what’s a “good” score? In today’s environment most commercial lenders want the small business borrower to score at 680 or better. That, of course, is in addition to all the usual factors including the profitability of the business, cash flow, and other outstanding business and personal debt.
Knowing how to manage one’s personal credit starts with getting copies of all three credit reports for free at Annual Credit Report which shows the details of your credit history without a score. By law you are entitled to receive each report once a year at no charge. If you want to see your scores you do have the option to include that for a fee.
Many people create a reminder system to access one report every four months, for free, in order to see new information more regularly. Each report will list all accounts (“tradelines”) as reported to each credit bureau. You will have the opportunity to challenge and correct any inaccuracies that could be affecting your score. Don’t be put off by the process, which requires you to document your concerns in writing – it’s worth the time and effort to remove inaccurate dings on your credit.
Repairing the damage
How can you boost your credit score? Unfortunately, negative information has a long shelf life on credit reports. Most information is reported for seven years, while bankruptcies stay on for ten. Even if you’ve paid off an overdue bill in full, that experience will be reported for seven years. So in many respects, only time can heal your credit report.
Going forward, the most effective way to increase your score or maintain a good score is to pay your bills on time, every time. One 30-day late payment won’t have a huge impact, but a pattern of slow payments will greatly lower a score.
The most effective way to increase your score or maintain a good score is to pay your bills on time, every time.
Another positive step may seem a little unintuitive: don’t cut up those paid-off credit cards! A large part of a FICO score comes from something called, “revolving available,” which is the percentage of unused but available credit. Only close these if a lender makes it a condition of a loan, otherwise try to keep the revolving available percentage as high as possible.
If you’re new to the world of credit – let’s say you’ve only had store or gasoline credit cards – your credit score is going to be low, because there is no experience on which to judge your credit worthiness. You’ll need to start building a positive credit history. How? Get a credit card and start using it on a regular basis. Pay it off every month and then ask to have your available credit increased. That activity will be reported and your score will start to rise.
It’s human nature to try to ignore bad news, but that’s not how things work in the world of credit reports. If you start running into problems making payments on time, be proactive. Finally, should you run into problems making on-time payments, be proactive. Contact your creditors and keep the communication lines open. You may find they are receptive to working with you as you work through a rough patch.