Sooner or later you or your business will need credit. Whether it is for something personal like buying a new car or stocking up extra inventory for your business –you will require more finances than what you have in your bank account. In such times, your credit score might become a critical factor in getting the money on time. We say ‘might’ because alternative financing doesn’t rely as heavily on credit scores as traditional banks and credit unions do. With excellent business revenue records, you can qualify for the cash you need from an alternate financing company regardless of your credit score.
What does a credit score do?
Simply put, it tells lenders how likely you are to pay them back. It does so by encapsulating and analyzing your past behavior with existing trade lines. If you rate high on the scorecard, you will get better rates, larger sums, and eventually lenders will roll out the welcome mat for a low-risk client like you. At the other end of the spectrum, if your credit score is low, you will rarely get funded by traditional sources.
How are credit scores calculated? What do credit bureaus look at?
- Payment history
- Credit utilization ratio
- Types of credit used
- Duration of the credit use
- The total balance on all debts
- Public records like bankruptcies
- Number of credit accounts applied for recently
So, improving a credit score is akin to building your reputation – and we all know that reputation takes time to grow. But here are some ways in which you can hasten the process:
Improving your credit score
1.Timely bill payments– Reliability is what lenders are looking for, and to understand this, they scrutinize your small money habits as much as the big ones. Paying all bills, and not just the credit card ones, signals to them, that you are someone who has the right habits and mindset.
2. Keep a low utilization rate– How much of your life is funded by credit is another factor that most lenders look at. This is your credit utilization rate and it is also defined as a percentage of your total credit limit. A simple way to calculate it is to divide your current debt by your total credit limit. For example, if you have two credit cards with a total of $10,000 limit and your credit card debt is $4,000, then your utilization rate is 40%. Anything over 30% shows you in a poor light to potential lenders.
Don’t close old cards & Do not open too many new ones
Closing old unused credit cards not only increases your utilization rate, it also disrupts the data flow to credit agencies. They might remove all data from old cards, and you will lose any goodwill you built on them. It will shorten your average credit age and affect your credit score negatively.
Opening too many new cards is not recommended either. It makes you look desperate for money, which is a trait associated with high-risk individuals. Every time you apply for credit, you lose 5 points on your credit score for a few months. If you apply for credit cards frequently, it can damage your credit score considerably.
1. Check your Credit Report
Credit report agencies can also make mistakes. Errors and identity theft might also affect your credit score and go undetected. Periodic checks will help you catch and fix mistakes before they escalate and dent your score.
1. Other ways to improve your score:
- Get a secured card linked to a deposit or your account.
- Become a joint account holder or an authorized user on someone else’s credit card.
- Ask for a limit increase on your current card. This will decrease your utilization ratio.
- Pay utility bills and rent on time and ask the company or the landlord to report your credit habits to the credit bureaus.
For Businesses
While a personal credit score can help businesses access credit, it is impossible to rely on them in the long run for larger business capital needs. Personal credit scores can help with small funding needs, but they don’t count much when you need big dollars to expand your business. So, it’s best to start building your business’ credit rating as soon as possible.
What is business credit?
Business credit is similar to personal credit ratings, except that it is linked to your employer identification number (EIN). It looks at the financial history of your business and examines how credit processes are handled and repaid. Some standard parameters most credit agencies consider are:
- Credit history- this includes utilization rates, repayment history and patterns, and general trends.
- Business and industry details such as how long you have been in business, industry outlook, size of your company, etc.
- Legal public records on any financial or business judgments, mergers, purchases and sales, and issues such as bankruptcies.
How to build business credit scores:
1. The first step is to register your business. This will establish it as a separate legal entity and separate your personal finances from the business ones. As a unique entity, the business will now conduct its own operations such as buying and selling to vendors and entering into partnerships and contracts. This means your business activities will now reflect in the credit agencies’ database.
2. To start creating a credit history, you will need an Employer Identification Number (EIN). All your business credits will be linked to the EIN and would also be used for tax purposes.
3. To separate your financial dealings from the business ones, you will need to keep separate bank accounts. A corporate bank account creates transparency around fund usage in businesses and makes it easy for credit agencies to track your money matters.
4. Credit agencies also collect information from business directories. To register or list with these directories, you will need a business address and phone number.
5. Start creating trade and financial partnerships with lenders, suppliers, etc., to create a vibrant credit history.
6. Get a business credit card or line of credit.
Key Things to Remember
In the end, all the formula and criteria used by credit agencies come down to this one question–can you be trusted to pay back the credit you take? To answer in the affirmative is not too hard. Building good credit is a straight forward process – you have to use common sense ways to show that you or your business is financially responsible.