May 20, 2014 | 5-minute read (831 words)
Guest post contributed by Nik Milanovic, Funding CircleUSA.
It’s estimated that large bank lending to small businesses fell by more than 50% during the recent recession. 1 And post recession, lending by banks and other traditional lenders has been slow to recover. With lending still tight, it’s no easy feat for small business owners to access the credit they need to build their credit profile and keep growing their businesses.
The dearth in lending has led many small businesses to turn to alternative lenders for capital. Some, such as peer-to-peer lenders, offer loans similar to banks'. It's usually easier to qualify for a loan with a peer-to-peer lender because they often take a more holistic approach to evaluating loan requests, including looking at total assets and a business' growth over time. But some alternatives, such as merchant cash advance lenders, impose much higher rates.
So what does this mean for you as a business owner? It means that bank loans now come with more requirements and tougher restrictions. One data point: as of March 2014, small business loan approval rates from big banks remained stagnant at only 18.8%.2 Banks are unwilling to make loans to businesses they see as risky – and that designation continues to include the majority of loan applicants. A big part of perceived risk comes from a business’ credit score; so maintaining a healthy one can mean the difference between approval and denial when it comes to a loan.
The good news is that there are several ways to maintain a high business credit score, greatly improving your chances of getting a loan:
Maintain a low credit balance. It may seem counter-intuitive, but the best way to get additional credit is by proving you don’t need a lot of credit to begin with. Lenders look at total credit utilization when you apply for a loan, which is a measure of how much of your available credit you are currently using. If your current balance is low, lenders know that you’re not stretched for credit and likelier to make late payments or default. There are three main ways to lower your credit balance:
1. Spend less on credit — try to use more cash and less credit when making purchases.
2. Increase your credit limit — call your credit card company and ask it to increase your available limit (a word of caution: this might require a hard inquiry, which will temporarily lower your score.)
3. Open an additional credit account — multiple credit accounts signal to lenders that you are more trustworthy. They also increase your available credit. But, just as with increasing the limit on one account, adding accounts may also require a hard credit pull, temporarily lowering your score. Also, make sure you understand all the terms and conditions before you open a new account – many come with great introductory rates and fees but then quickly ramp up.
Make sure to regularly check your current credit reports. Many factors influence your business credit, and regularly checking your report can help you understand how they factors impact your overall score. It's important to note that asking for your own report will not harm your business' credit rating in the same way a hard inquiry does your personal credit score. Be sure to pay attention to any negative items on your report and work to resolve them as quickly as possible.
Make timely, regular payments on all purchases. One of the best ways to convince a lender that you are a great credit risk is, simply, by being a great credit risk. If you make timely payments on all your purchases, better yet, before the due date, your credit score will gradually improve. On top of that, paying down your entire credit balance each month, instead of just making the minimum payments, keeps your credit utilization low, improving your score even more. Missed payments cause the biggest hits to your credit score – be sure to set up reminders so you know when due dates are coming up.
Of course, business credit isn’t the only consideration that lenders look at when they evaluate your business for a loan, but it is a major factor. If you follow these steps, you'll ensure that your business credit grows healthily alongside your business.
Nik Milanovic is a Senior Analyst at Funding Circle USA, the United States' largest peer-to-peer lender for small businesses. Funding Circle provides loans of $25-$500K to high-quality entrepreneurs looking for expansion, capital, equipment purchases, or more general needs. For questions about lending or tips to pass along to small business owners, contact Nik at firstname.lastname@example.org.