Lenders tend to offer favorable terms and lower interest rates to borrowers with good credit history. Getting quick access to available financing options to sustain your small business and improve poor credit is possible but tricky. Regrettably, not every small business has an excellent credit score to qualify for bank loans at favorable terms and lower rates. If your small business is unable to qualify for a bank loan, where you can turn to?
Getting quick access to business financing options with bad credit is difficult. With proper research and understanding of available financing options, you can get a business loan with bad credit. Alternative lending is on the rise offering personalized financing options to businesses when banks are reluctant or unable to provide access to financing to small businesses. However, before accepting funding from alternative lenders, you should be astute; else, you might get yourself into more debt.
What factors do lenders consider when approving a loan application?
When your small business needs funding, you might first turn to banks and traditional institutions. These lenders typically provide a range of from term loans, SBA loans to lines of credit and personal loans. Theses lenders take into account different factors when approving a business loan application, including:
Credit Score: Credit score is the most crucial factor lenders consider when evaluating borrower creditworthiness and that includes your business credit score and FICO credit score.
- A business credit score is the measure of a business’s creditworthiness that you can check by getting your business credit report from credit bureaus (Equifax, Experian or Dun & Bradstreet). The standard factors that go into your creditworthiness include credit utilization, time in business, owner’s personal credit score and the size of the business.
- A FICO credit score is your personal credit score, ranging from 300 to 850. The factors that contribute to your FICO credit score includes debt repayment history, length of credit history, outstanding debts, and your current new lines of credit.
Debt-to-income ratio: Lenders use this ratio to determine your ability to manage the monthly payments to repay a loan you plan to borrow. To calculate this ratio, you add up all your monthly debt payments and divide them by your gross monthly income.
Liquidity: Different lenders have different liquidity requirements for businesses. They want them to maintain a few month’s worth of expenses in reserves. Some might ask for three months of cash reserves, while some for six months or more. It provides a safety net to the lenders that if something unforeseen happens, a business can still manage the loan payments.
Collateral: Some lenders may require your valuable assets as collateral to secure the loan in case you do not have sufficient money at hand to make your loan payments. The common assets used as collateral are real estate, car, equipment or machinery.
Financial Statements: Almost every lender will require you to provide a few months of your financial statements to understand the financial strength of your business. Lenders typically require this to determine the loan rate.
What are the types of small business loans you can qualify with bad credit?
When your small business needs money and you have a bad credit score, and conventional lenders are not the option, you can get financing options from alternative lenders or online lenders. With these lenders, you can get quick access to working capital at the flexible terms, fast approvals and affordable interest rates.
The most common small business loans you can qualify with bad credit scores include:
- Short-term Loans & Lines of Credit: You can get short-term loans for three years or less and business lines of credit with one year or less. These loans and credit lines are also suitable for borrowers with good credit scores because of their low cost and easy approval. If your business is generating enough revenue and has cash reserves, you can easily qualify for short-term loans and credit lines even with a bad credit score.
- Collateralized Loans: You can also get collateralized loans with bad credit. These loans are backed by collateral – making your credit score irrelevant for the lenders in the approval process. The collateral provides a safety net for the lenders in case you default, the lender can seize the collateral and sell it to recoup the loss.
- Invoice Financing: Invoice Financing is another suitable option for bad credit borrowers. In this financing option, you sell your unpaid accounts receivable to a factoring company at a reduced rate (typically ranging from 80% to 90% of the total value.). The factoring advances you the money and typically collects payments from the customers on your behalf. It’s also a suitable financing option for seasonal businesses or when you need funding for growth.
- Merchant Cash Advance: When you need quick cash, a merchant cash advance (MCA) offers you a lump sum amount of money (plus fees) in exchange for a percentage of your future credit and debit card sales. It is not technically a loan, instead, a type of financing that is backed by your credit card revenue. Merchant cash advances are the most expensive financing option with very high APRs as high as 350%.
Before you apply for any type of bad credit business loan, do your homework and use due diligence when finalizing a lender. Also, ensure the lender is reputable and closely review the loan agreement before signing on the dotted line. And most importantly; only apply for the money you can realistically repay in the specified time.
How to repair your bad credit score?
There are many benefits to repairing your poor credit score even if you do qualify for a business loan. Rebuilding a poor credit score is a long and strenuous process, but once you start working to improve it, you will be able to secure better terms and lower rates on your bad credit business loan.
The first step in repairing your poor credit score is to stay current on your personal credit payments. Maxing out on your credit card payments can considerably affect your credit score. Even a single missed payment or making minimum payments can also significantly bring down your credit score.
Repairing credit score can be an extremely difficult process and typically necessitates planning. You also need to scrutinize your business’ debt service while maintaining your personal credit score. A cash flow projection is also important to manage cash reserves and decide what to pay for.
If you’re short on cash, you can also ask your suppliers to extend the payment schedules so you can have the cushion to manage your monthly payments. If you’ve worked with a lender before, you can also renegotiate your repayment terms or can secure more cash, provided your business is on the road to financial recovery.
Bad credit is a vicious cycle and sometimes it’s almost become impossible to evade. When things do downhill, the cost of borrowing goes up, so you have to evaluate how to stabilize your business. Once you are able to sustain it, you can then focus on credit repair.
Financing can be a great tool to grow your small business, but if used recklessly, it can become a disaster for a cash-strapped business. In the end, getting money should be a way to put your business in a better place in the credit spectrum. Therefore, when you plan to borrow money in the future you can secure favorable terms and lower interest rates on your business loan application. Also, make sure you have a plan in place for borrowing and communication with the lenders, so you can be on your way to repairing your credit.