HOW FICO FACTORS INTO FUNDING
As hard as you work to separate business from personal – whether you’re talking about your income, assets, or liabilities – why is it that so many small business owners are being impacted by their personal FICO score when applying for business credit?
In general, the Fair Credit Reporting Act specifically states that the personal credit report should not be considered in commercial credit decisions. Even so, the FCRA goes out the window the moment you put your social security number on the application, immediately converting your commercial credit application into a consumer credit application. This allows creditors to consider personal credit in their decision. For this, you can blame both the credit underwriters and the Patriot Act, which mandates them to gather personal information from every applicant to help combat the funding of terrorism.
This is not to say poor personal credit scores will keep you from achieving credit approvals. Quite the contrary. Personal credit is not the prevailing factor. We have seen credit approvals run the gamut, including small business owners with 700+ credit scores getting denied for major credit cards and loans, and others with 500 FICO scores getting approved. The fact is, there is a lot more to getting an approval than just a strong FICO or Paydex© score.
In reality, credit approvals are based upon a combination of these scores, but will also include your company’s gross annual and monthly income, the income-to-debt ratio, prior personal and business credit history, and your company’s age and ability to repay the debt on time.
Most creditors will blatantly tell you, “You don’t have to put your personal information on your business credit application,” but then are quick to add, “and we don’t have to approve your application.”
There are some who suggest leaving your social off the application altogether, which may work for those businesses who have already established a strong corporate credit report. And there are others who have recommended using a fake number or CPN, but this could open you up to outside liability, fraud, or charges of identity theft.
When in doubt, the best recommendation is to use your own social security number and only if it is a requirement on the application. You can usually find out if it is required simply by calling the creditor prior to completing the application. Many creditors can check the strength of the business credit file while you are on the phone and make a determination as to whether they will require the personal information before you apply.
Preparing the business credit file in advance is still the best proactive practice and should be completed in the two months prior to the application process. Much like consumer lenders, business creditors will check your company’s credit file for the following factors:
Current payment status – which includes the number of trade relationships, high credit, balances and what percent is delinquent
Credit utilization – which shows the amount of credit available vs used
Derogatory information – such as any slow payments, collections, liens, judgements and bankruptcies
Historic data – such as payment behavior, the types of credit, and payment trends over a period of time
Demographic data – including the age of the business, the industry, employee count and number of inquiries on your file
Once we have helped our clients to build a strong business credit file, we usually refer them to various funding sources depending on their specific needs and goals. Several of the lenders we recommend may require a soft pull of the personal credit report to confirm the applicant meets one of the most basic eligibility requirements – a 500+ FICO score – and then check the business credit file and gather the supporting documentation.
This is not to say the creditor is going to require a personal guaranty, or that the credit will be associated to the personal credit, only that you’ll meet their underwriter’s criteria for funding. A 500+ FICO will get your foot in the door. Anything above a 500 will work to lower the interest rate or expand options on the loan, such as repayment schedule, method of repayment, and overall length of the contract.
In recent conversations with some of our funding sources, we were encouraged to hear they are relying more heavily on the business file and placing less emphasis on the personal. For many small business owners with less-than-perfect personal credit, this could be the change they have been waiting for.
LESSON: While focusing on improving your FICO score is never a bad thing, the goal is to achieve various types of credit that do not rely heavily on your personal credit scores so that your business grows stronger legs to support itself.