Business Loans for Bad Credit Applicants: Do They Exist?
Running a business is hard, and it’s even harder when you’re strapped for cash. Overcoming financing hurdles can feel nearly impossible when you’re trying to do so with bad credit. While a low credit score will surely impact your ability to access certain types of business funding, there are still many options to consider when it comes to business loans for bad credit.
Struggling to obtain business loans for bad credit is not a unique problem. According to the Biz2Credit Small Business Lending Index, big banks only approved 24.2 percent of loan applications in March 2017. Though it has always been difficult for small businesses to land a traditional bank loan, bad credit can amplify the challenge – it’s one of the most common reasons loan applications are rejected. Generally, a credit score of 600 or lower is considered poor. Credit bureau Experian claims that nearly one-third of Americans have a score that falls into that category. No wonder so many small business owners have trouble getting business loans.
Challenges of Getting Business Loans for Bad Credit
When a bank reviews your loan application, they will examine your credit score. Your score acts as an index of your fiscal responsibility. If you sensibly manage your money, pay bills on time, and responsibly use debt, you should have a good score. Lenders use your score as a measure of creditworthiness – the higher the score, the more likely you are to pay back your loan, which means less risk for the lender. Banks don’t want to lend money to businesses with a bad credit score because they are afraid they won’t get their money back.
It takes several years for a business to build a credit score. Even after that time, some business owners have not built credit in the name of the company. As such, when a company does not have its own credit rating, financial institutions will default to the personal credit score of the business owner when considering whether or not to lend money. Often, this is not a fair reflection, as the individual’s score could be impacted by outside factors irrelevant to the business. Nonetheless, without historical information on the business and its financial record, the owner’s personal score is the next best thing.
Many small business owners are in the dark about their business credit profile. The Nav American Dream Gap Survey revealed that 45 percent of small business owners surveyed did not know their business had its own credit profile. Seventy-two percent of participants did not know where to find information on their business credit profile and 82 percent did not know how to interpret their score. Without education about how business credit scoring works, business owners are not able to lay the proper foundation to ensure their business builds a good score. For example, businesses need to forge relationships with vendors and suppliers, and demonstrate the ability to pay promptly on time in order to forge business credit. They must also show that they can responsibly use credit cards in the business’ name. Businesses need to prioritize the development of their credit profile from the start to lay the foundation for their future financing needs.
If a company is able to find a willing lender despite its poor credit, it might still struggle with the fees and rates. Often, when offering business loans for bad credit, lenders will try to make up for the potential risk by charging exorbitant interest and other fees. Businesses with good credit are able to get the best rates and terms available.
Available Options for Business Loans for Bad Credit Applicants
Though businesses with bad credit don’t have as many financing options available, there are several methods they can use to get the cash they need:
- Term loans from alternative lenders: Online lenders employ non-traditional factors to determine whether or not to give a business a loan. These include measures from sales projections to social media followers. Alternative lenders offer both short and long-term loans, depending on the business’ needs. The loan application and funding process are much quicker and simpler with alternative lenders than with their traditional counterparts.
- Secured loans: A secured loan is when a business owner offers up something valuable as collateral. This often makes it possible to get a secured loan with poor credit, as the lender can take the collateral to recoup some costs if the business defaults. While this means less risk for the lender, it’s a tremendous risk for the business owner.
- Co-signed loans: Sometimes, businesses with bad credit will bring on a partner with good credit to co-sign for a loan. Co-signing means that person is responsible for the debt if the business defaults. It is a gamble for the cosigner but can help the businesses get access to cash.
- Working capital loans: These short-term business loans are used to fund day-to-day operations. They are quick to fund and businesses don’t typically need to meet many requirements to get one. A business with very bad credit can get a working capital loan by putting valuable assets up as collateral.
- Equipment financing: Often, the most expensive investments businesses need to make are in equipment like commercial machinery, vehicles, or manufacturing tools. Equipment financing lets businesses buy this equipment by paying little by little over time (plus interest). Even businesses with bad credit can finance equipment because the equipment itself is used as collateral. If the business defaults on payment, the lender will repossess the equipment and sell it to make up the difference.
- Invoice factoring: Invoice factoring, or accounts receivable financing, lets a business get cash immediately by selling its accounts receivables to a factoring company. The business gets money up front (minus fees) and the factoring company collects on the invoices. Invoice factoring involves low risk for the lender because it involves money the business has already made, so it’s a solid option for businesses that can’t get other loans because of bad credit.
- Merchant cash advance: A merchant cash advance gives a business a lump-sum payment that is paid back daily by automatically deducting a small percentage of its credit card and debit card sales. Businesses with bad credit can get a merchant cash advance because lenders are more interested in the company’s sales figures than its credit score. Since payback is processed automatically based on credit/debit card transactions, lenders are guaranteed that money goes directly to them.
Risks Associated with Getting a Business Loan While Having Bad Credit
Business loans for bad credit can help your business get the money it needs, but they could further damage your credit score in the process. Your debt-to-credit ratio is weighted heavily when calculating your score. Taking on more debt will negatively affect that ratio. There are some situations where this risk can be worthwhile, for example, when a business needs the money to fund a large purchase order. Unless there is a very clear line from the loan to increased revenue, it might not be worth the risk. But, if you are able to responsibly pay off your bad credit business loan, it will go a long way towards improving your score in the long run.
Businesses with poor credit can expect to pay significantly higher interest rates than those with good credit. Over the lifetime of the loan, this can mean an exorbitant amount of money beyond the original loan amount. Businesses with bad credit will also have to deal with more stringent repayment terms. With one bad month, they could fall behind in payments and risk default – there’s not a lot of room for leniency.
Securing a loan with collateral amplifies the risk for business owners since most collateral will likely be personal (vehicle, home, etc.) Losing a business is bad enough, but defaulting on your loan will also mean losing your collateral. This can be a ruinous mix.
Though small business loans can be the ticket to business growth, they can also put a stress on the business it just can’t handle. Entering into a loan should be well thought through. Overcommitting the business and its resources could bring failure.
How to Fix Bad Credit to Get Good Business Loans
If bad credit plagues your business, don’t despair. There are many things you can do to build your score back up so that you can have your pick of business loans.
- Pay your bills on time: Paying promptly (and early, if possible) will do wonders for your credit score. You don’t need to pay the whole balance if you can’t, just be sure you’re meeting the minimum. Set up auto-pay or calendar reminders if you have a hard time staying on top of payment due dates.
- Reduce debt: Though paying the monthly minimum is good, getting all the debt paid down is better. You don’t have to do it in one fell swoop, just watch your overall spending and start putting any extra money towards the debt with the highest interest rate. Slowly, you’ll bring your debt-to-credit ratio down, which will improve your score.
- Renegotiate interest rates: Once you start missing payments, interest rates will soar, which only makes you fall further behind. If you’re really committed to getting your debts paid down, contact your creditors and see if they’d be willing to negotiate the interest rate. You can also consider consolidating debts for better interest rates.
- Monitor your credit score: Occasionally, a credit bureau will make an error on your credit report, so it’s important that you check it to ensure a mistake is not pulling your score down. Examining your score can also help you identify the specific areas where you need to improve. You can request a copy of your credit report directly from one of the credit bureaus or you can subscribe to a credit monitoring service that will watch your score for you.
- Pursue credit counseling: If fixing your score feels too overwhelming, you can meet with a credit counselor who can help you create an actionable plan to start paying down your debts. In many situations, credit counseling is free to companies and individuals in need.
Whether you decide to get a business loan with bad credit or wait it out until you can improve your score, make sure you stay on top of your payments and keep your eye on your goals. Successfully managing any business loan, bad credit or not, will show lenders that you can handle debt. This will put you in a better position to access more options, and score the best rates and terms for any future financing needs.