Business LoansBusiness Lines of Credit: Where to Find Funding in 2020

How to Get a Business Line of Credit for Bad Credit

There are many moving parts that make a business successful, such as hiring the right people, a solid business plan and paying customers. They also need access to credit, whether that’s to buy materials, expand or meet short-term expenses during a cash flow crunch.

Business funding takes several forms, but they all have at least one thing in common; the applicant needs to be creditworthy. Credit scores help lenders determine how likely a borrower is to meet the deal’s financial obligations.

Although there are two credit scores that can be used in a business lending decision, personal or business credit score, some lenders will only consider the personal credit score of the business owner.

What is a business line of credit?

A business line of credit is a set amount of funds made available to a business by a lending institution, which typically comes with a fee. The business doesn’t have to use all the funds that are extended, but many businesses need it to pay unexpected bills, purchase inventory for seasonal sales or to cover short-term expenses during cash flow issues.

Brad Rivers, director of Gaston College’s Small Business Center in Dallas, N.C., said a business line of credit can be distributed in a few ways: by writing a check, depositing the funds in their account or through an online account the business can access. Most lines of credit have a term of 15 years. Some lenders, however, may have a repayment plan that allows the business to borrow up to the limit and repay as needed for the first 10 years, while simply paying down the remaining balance over the last five years of the loan.

Lenders will have different repayment terms, depending on your unique situation. “[The lender will] let you know,” Rivers said with a laugh. If you find you’re unable to make a payment, it’s vital you inform the lender before the due date. He said it’s usually OK if it’s documented ahead of time, especially with a promise to double the next payment.

Pros and cons of a business line of credit for bad credit

Businesses should review every funding option available to them and carefully decide if it offers the best terms. A business line of credit has several unique characteristics when compared to other forms of financing.

First, the business only pays for it when it uses it. “People quite often deal with it like a credit card,” Rivers said. And it’s flexible, offering as little or as much — up the spending limit — as needed at the moment. Payments will fluctuate with how much is owed on the funds, which can make budgeting difficult.

Here are some pros and cons to a business line of credit:

Pros:

  • Allows for the quick handling of unexpected expenses.
  • Bridges short-term cash flow issues, such as when bills are due or you have many outstanding invoices.
  • Helps improve credit score if payments are made on time.

Cons:

  • It might be more expensive than other types of funding.
  • It’s an easy way to purchase materials and supplies, so businesses can easily over obligate — making promises to customers that they can’t deliver on. Rivers said they’ll eventually reach the line’s limit, and there might not be another means to purchase materials or fulfill orders.
  • Drawing down on your line of credit can exasperate cash flow issues, adding expenses — repayments — while only temporarily increasing revenue.

According to Marco Carbajo, a business credit expert, speaker and writer for Dun & Bradstreet and U.S. Small Business Administration, unsecured business credit cards offer the same cash availability as a line of credit. He said some may offer a higher spending limit or 0% APR for a limited time. They offer flexible payments, depending on the credit used, and responsible use can improve your credit score.

There are some downsides to unsecured business credit cards you should be aware of, Carbajo warned. The absence of a fixed payment schedule can make it easy to accumulate debt and interest rates associated with these cards are almost always higher than a traditional line of credit. Additionally, some have compounding interest, which greatly drives up your balance without making any new charges.

How credit scores are calculated

In general, Rivers said the better the applicant’s credit score, the better chance it’ll come with a reasonable interest rate. A bad score doesn’t automatically eliminate a business from receiving a line of credit; however, he said credit scores are often used to guide a deal. A business that has a low credit score can be approved, but will probably end up paying more for same amount of money extended to someone with excellent credit.

According to Experian, one of the big three credit bureaus, a good credit score can help secure an apartment lease, land a dream job, or secure financing with excellent terms.

Credit scores are based on several factors. The Fair Isaac Corp., whose FICO scores are widely used by lenders, rates your credit by evaluating five areas:

  • Payment history, making up 35% of your total score
  • Amounts owed, making up 30% of your total score
  • Length of credit history, making up 15% of your total score
  • New credit, making up 10% of your total score
  • Credit mix, making up 10% of your total score

Tax liens, civil judgements, bankruptcies and lines of credit also affect credit scores. New credit (hard pull) inquiries will have a minimal impact on your credit score, while multiple inquiries made in a short time — such as rate shopping for a mortgage or a car loan — are viewed as one inquiry.

It’s important to note, however, that each credit profile is unique, so everyone’s credit will be affected differently. The Equal Credit Opportunity Act prohibits lenders from making a lending decision based on gender, race or marital status, and will never impact a credit score.

Here is a breakdown of the FICO credit scoring model:

FICO credit score Rating Percent of Population Impact on borrower
850-800 Excellent 19.9% Offered the best interest rates
799-740 Very good 18.2% Offered better than average interest rates
739-670 Good 21.5% Only 8% are likely to fall behind on their payments
669-580 Fair 20.2% Considered subprime borrowers
579-300 Very poor 17% May have to pay a fee or deposit. Might not be approved at all

Source: Experian.com

Dun & Bradstreet Inc.’s PAYDEX score is similar to a FICO credit score except it’s for businesses and ranges from 1 to 100. Businesses with scores up to 49 are considered high risk (of late payments, for example), while those with a PAYDEX score of 50 to 79 are considered moderate risk. A PAYDEX score of 80 or above is considered low risk.

Understanding bad credit

Lenders use your credit score to determine how risky it is to extend credit. Someone with good credit will receive the best rates and terms, while someone with bad credit will pay a higher price to borrow funds.

A low or bad credit score typically results from a history of late or missed payments or other derogatory information, such as a lien. Having bad credit almost always makes borrowing money more expensive. When lenders agree to extend credit to a risky borrower, they usually attach a higher interest rate. The extra money is their reward, so to speak, for the risk they incur.

“Sometimes lenders will look past a low score,” said Rivers. For example, you might be very responsible with managing your credit and debts, but then a medical emergency occurs and causes you to miss payments, resulting in a lower credit score.

Rivers said lenders may also evaluate an applicant by how much they want, and weigh that against their employment and credit history. When considering all the different aspects that make up a credit score, it’s very possible that an applicant with a low score can get approved for a line of credit and someone with a high credit score could get denied for that same line of credit. These exceptions are made on a case by case basis.

How to improve your credit score

Bad credit isn’t permanent. Credit scores are calculated upon request from the lender, providing the most up-to-date score. Historical issues on your credit report will have less of an impact on your score over time, which is why it’s important to get your finances back on track as soon as possible.

Rivers has helped more than 2,400 individuals with business plans, permits and licenses. He also has helped many secure funding, and he tells each of them the same thing: Make your payments on time. It’s an easy way to improve a credit score, as long as the lender reports them to credit reporting bureaus.

You should never open up new credit accounts or accept lines of credit until after your financial situation has improved and you can responsibly manage your debt load. Experian suggests the following tips to improve your credit score or build credit:

  • Stay current on all debts: If you’ve fallen behind, contact your creditors and make a debt repayment plan that works with your income, and stick to it.
  • Open a joint account or become an authorized user: You’ll want to become an authorized user or becomes a joint account user only on an account that’s in good standing. Both parties are responsible for the balance on a joint account, so failure to make timely payments will affect both credit scores.
  • Open a credit card account:  Some credit cards — albeit with small spending limits — are available for individuals and businesses with not-so-great credit. Opening a new credit card should be done with caution, and only if you’re absolutely sure you will pay off the balance at the end of the month.
  • Request a credit line increase: Borrowers that use less than 30% of their available credit lines are considered less risky to lenders. You can adjust your credit utilization ratio by either increasing your available credit lines or by paying off a large portion of the debt. It’s important that you don’t use the additional line of credit if it’s extended to you.
  • Get an auto installment loan: Auto loans are fairly easy to get, but you should shop around to find the best rate.
  • Take out a secured loan: These are similar to secured credit cards, but you are borrowing against money you deposit in the account. Some banks accept existing accounts or certificates of deposit as collateral.

Dun & Bradstreet suggests the following tips to improve your business credit score:

  • Make the business independent: Sole proprietors are linked to their owner’s personal credit score, while corporations and LLCs are attached to a business credit score. Structuring a business as a corporation will establish it as an independent entity, separating it from the owner’s personal credit profile, although the business will have to develop a credit history.
  • Register for a DUNS: The DUNS number is a unique number that’s provided by Dun & Bradstreet. Lenders use this number to check your credit profile.
  • Get an EIN: The IRS gives businesses an Employer Identification Number, which is similar to a social security number for an individual. Establishing an EIN for your business allows credit to be attached to the business name. You can file for an EIN for free through the IRS.
  • Open a business bank account: A seperate business account will establish the independence of the business and keep personal finances separate. It’s can also be used to establish a track record with the bank, which can help you down the road when you may need financing.
  • Establish vendor credit: Not all vendors report to the credit bureaus. Make sure you are working with vendors that will report your payments. If you’ve worked with vendors in the past, contact them to see if they would be willing to back-report your payments to build good credit.

There are no easy fixes for bad credit. Experian estimates that it takes up to 60 days, for example, for a credit report to reflect that all credit accounts have been made current. You should check your credit report annually, if not quarterly, to ensure all information is correct and accurate.

Is a business line of credit for bad credit right for your business?

Now that we understand what a business line of credit is and how your credit is evaluated during the application process, let’s understand which businesses are good candidates for a line of credit with bad credit.

Rivers said almost every business can use a line of credit. If your business has inconsistent cash flow, a business line of credit may be good for you. If a business has short-term expenses — such as utilities, payroll or rent — due every 30 days, but its best or biggest customer pays its invoices at 90 days, then a line of credit can help bridge the gap in funds. “It’s a good back up,” Rivers said.

Fast-growing businesses, which often encounter unplanned expenses, can also benefit from a business line of credit to pay balances and business running. For example, it could be an optometrist who needs to float payroll while waiting for insurance reimbursements, or a restaurant -which has one of the highest rates of business failure- may need one to pay food vendors who may only work with them on a cash basis.

Alternatively, a business line of credit isn’t for everyone. Businesses must be able to make the payments on any portion of a line of credit used. If its cash flow forecast isn’t predicting enough money to make repayments, for example, then using a line of credit will only dig the financial hole even deeper. A well-thought-out payment plan should be in place before borrowing any money.

Shopping for a business line of credit for bad credit

When shopping for a business line of credit, some of the first things you should consider is the interest rate attached to the offer and the term. Check the deal’s fine print for fees or penalties that may not have been mentioned up front.

Rivers suggests looking at more than the dollar amount by researching the lending institution. Do past and current customers say it’s easy to work with? How accessible is the money? Are there hoops to jump through each time money is needed or is it only a phone call away? Reach out to your business network and ask which lenders they used and what the experience was like.

The best lenders will make financial information transparent and won’t hide any terms or fees. Make sure the line of credit is enough for all your business needs, or it may not be worth pursuing.

Applying for a business line of credit

The application process for a business line of credit is specific to the lender and deal, and the applicant’s credit history, including individual or business credit scores. A business may be required to provide several years of tax returns–from the business and its owner–and may have to provide references from creditors, vendors or even its landlord.

“They are looking for confirmation that you are paying your bills,” said Rivers.

Most (if not all) lenders will review the business’s books and may request collateral or attach rules to the line of credit, such as the institution handling account receivables to ensure repayment or signing off on capital purchases. Some may even request a seat on the business’s board of directors, which is another way of protecting their investment.

The approval process can be intensive under the most credit-worthy applicants, and for a business with bad credit, it can be fraught with hurdles.

How much will a business line of credit for bad credit cost?

Businesses with bad credit can expect to pay more interest on any line of credit opened for them, explained Rivers. “They’ll give you a line of credit, but it [for example] will include 24 percent interest,” he said. “That’s not much of a deal.”

Interest is usually calculated at the interest rate, plus the prime rate of lending, which will depend on the individual borrower. Take time to calculate how that will affect the cost before accepting a deal. The business needs enough cash flow to cover those payments.

Bottom line

Nearly every business needs a line of credit, whether it’s to cover outstanding invoices or buying materials and inventory. Securing a loan depends on many factors, but the most important point is understanding that the better your credit score, the better your loan terms.

While a business with bad credit may still be offered a line of credit, its cost may be prohibitive. In those cases, better solutions may be to improve your credit score in hopes of landing a more favorable deal.

 

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