Keeping Strong Credit Scores During a Recession

It doesn't matter how long you've been in business, building and maintaining a strong credit profile is an important part of qualifying for small business financing. This is particularly true in the post COVID-19 world we live in today. What's more, this is not only true for your business credit profile, but your personal credit score will be a part of just about every creditworthiness evaluation you will experience as a small business owner.

What we're seeing today looks familiar to many of us who have lived through recessionary times before. Following the financial crisis in 2008 for example, many lenders lowered credit limits on their customer's lines of credit, tightened their lending criteria, or stopped making small business loans altogether. This was disproportionately true for the smallest small businesses and took a few years before we saw much improvement. The biggest and most creditworthy businesses were finding success with small business-borrowing two or three years before many of their smaller, and less creditworthy, small business peers.

That isn't to say there weren't options. It was at that time many online lenders and other alternative lenders captured more of the market. They evaluated creditworthiness differently from traditional business lenders like banks and credit unions, but access to that capital came at a cost. Many of those options were more expensive than a low-interest term loan from the bank. The trade off was a quick approval process (days instead of weeks) and funding as quickly as within a few days more.

The biggest difference between this new breed of lenders and the traditional lenders of 20 years ago, is that these new financing options require a more savvy borrower to take advantage of a lot of lending that targets specific use cases and carries with it a higher cost. This is still true today. Equipment financing, factoring, merchant cash advance, and other short-term financing won't meet every business need, but they will be some of the few financing options available during a recession, so borrowers need to be asking themselves, "What am I borrowing for? before they start talking to lenders. The answer to that question will help them know where to look for a loan, how much money to ask for, evaluate their personal credit situation, and determine if they have the cash flow to make periodic payments and whether or not the cost of the financing makes sense for their business.

Even though this new breed of lenders looked at creditworthiness with a different paradigm, they still relied on the credit reporting agencies to give them insight into what borrowers had done in the past so they could make decisions about what they would likely do in the future. In other words, during times like we are facing now, your credit profile is more important than ever before.

If nothing else, the crisis caused by COVID-19, the Paycheck Protection Program (PPP), and the Economic Injury Disaster Loan (EIDL) program illustrated the importance of building and maintaining a strong credit profile. There were numerous small businesses in need of PPP or EIDL funds that were turned away-even though the SBA relaxed the qualification requirements for a loan guarantee.

What you need to know about personal credit

As a small business owner, in addition to your business credit profile, your personal credit score will likely always be the part of any business loan application decision. With that in mind, there are some things you need to know about your personal credit score, how it's calculated, what you can do to improve it, and how it impacts your business loan application.

Although there are slight variations among the different personal credit reporting agencies, your personal credit score is based on the FICO score and represents five important metrics you should pay attention to.

1. 35% of the score is based on your payment history. In other words, the single most important thing you can do is to make each and every periodic payment in a timely fashion. Most creditors understand the difficulties people are facing right now, but that doesn't mean you'll get a pass. It's important to stay current and definitely not allow a debt obligation to go 60-, 90-, or 120-days past due.
2. 30% of the score is based on your debt to credit ratio. In other words, the ratio of debt you use compared to the amount of credit you have. The credit bureaus don't like to see maxed-out credit accounts. A good rule of thumb is to keep that ratio below 15%, but anything over 50% is a big red flag that will keep your personal credit score in the basement.
3. 15% of the score is the length of your credit history. Remember, lenders are trying to make decisions about what you will do in the future based on what you've done in the past, so a longer track record is better than a shorter track record. You'll probably get some allowance for the first half of 2020, but if you have chronic credit problems dating from before the crisis, you need to get to work on making improvements to your credit habits.
4. 10% of the score is based on the type of credit you use. For example, credit bureaus look at mortgages, auto loans, credit cards, and other revolving debt through a different lens. Creditors want to see a mix of credit, so if the only credit account you have is your mortgage, a little diversification will help your credit score.
5. 10% of your score is based on new credit inquiries. While it's true that new inquiries can impact your score, the amount of impact is relatively small. That is particularly true if you are consistently current with your payments and aren't maxing out the limit on your credit cards every month.

Knowing the metrics is the first part of this one-two punch. Monitoring is the second part. We tend to impact the things we pay the most attention to, and this applies to both your personal and business credit. In addition to building relationships with the individual credit bureaus, there are some free options available you should be aware of.

For starters, Chane Steiner, the CEO of Creditful.com says, "While the pandemic is hurting many people financially there is one thing to keep in mind: The CRA's unanimously agreed to extend free credit reports via annualcreditreport.com to consumers on a weekly basis through the end of 2020 (normally accessible once per year for free).

What you need to know about business credit

Regardless of how long you've been in business, you have a business credit profile that includes detailed information about your business and your business credit history-including how you pay your utility bills, make payments on your business credit cards, along with how you pay your suppliers and other creditors.

Like your personal credit score, the first step to building a strong business credit profile is monitoring. Unlike your personal credit score, your business credit is usually a collection of scores and reports that detail your credit history along with how your business compares to other businesses of similar size, other businesses in your industry, other businesses with a similar number of employees, and other businesses in your region.

Although your personal score is considered private, your business profile is public to anyone who wants to see it. The basis of your score is whether or not the majority of your credit interactions are positive or negative. The goal here, like the primary metric on your personal credit score, is to meet all your business obligations as agreed upon. 

If you have a less-than-perfect business credit profile, here are four things you should be doing to maintain a strong history during a recession like we're experiencing today.

1. Make sure your profile is accurate: There is a lot of negative credit activity going on right now and it's easy to confuse businesses with similar names or addresses, so it's more important than ever to make sure the things being reported about your business are accurate and reflect your credit practices. If you find an error, all the major business credit bureaus have mechanisms to correct the mistakes you can verify.
2. Keep your personal and business credit separate: This can be difficult for young businesses that don't have a lot of business credit yet, but using your personal credit for business credit purposes not only doesn't help your business profile, it could actually hurt your personal credit score. Because 30% of your personal score is a reflection of how much credit you use compared to how much you have, the higher balances often associated with business expenses can negatively impact your ratios. If you want to keep your personal score as strong as possible, while building your business profile, avoid the temptation to use your personal credit to pay for a business expense.
3. Establish trade credit accounts with your suppliers: This is one of the most underrated ways to build a strong business profile. Most vendors are willing to offer payment terms to their good customers. Although it's not a business loan, if they report your good credit behavior to the appropriate credit bureaus, this valuable credit will help you build a strong business credit history that will enable you to borrow when you really need to.
4. Use the credit you need and stay current: Businesses large and small leverage borrowed capital to fuel growth and fund other business initiatives. The biggest thing you can do to build a strong profile is to use the credit you need and make sure you make each and every periodic payment. Lenders look at your history because they want some assurance that you will make timely payments to them because they can see you've done so in the past.

Post coronavirus, you can't afford to ignore your credit profile

When I owned my own business I occasionally had to rob Peter to pay Paul-but I never faced the challenges small business owners face today. Surviving and thriving in the post COVID world will require creative problem solving and grit. It will also require the discipline to stay on top of your credit obligations to maintain, and even strengthen, your credit so you'll have access to borrowed capital when you need it.

A strong credit profile might not be a guarantee that you'll be able to get the business loan you're looking for, but it will put your application at the top of the pile and give you more options than a business saddled with a lackluster credit history.