Many small business owners use personal credit to run their business. However, doing so could put you at risk if your business is ever in trouble. Plus, many creditors today are moving away from relying on personal credit alone when judging a business’s financial health since personal credit is not considered an ideal predictor of business behavior. Furthermore, smart creditors are taking advantage of new blended commercial scoring tools that integrate both personal and business credit attributes to assess and predict small business risk.
However, if you are a sole proprietor, your personal credit and your business credit are closely linked in the eyes of banks and other lenders. So it is important to take steps to protect both. You should monitor, evaluate and protect your credit standing just as you would protect any other business or personal asset.
Why Is It So Hard to Get a Loan?
The lending business model is simple. Interest rates earned from the loan payments must be higher than the probability of the bank not getting paid back. For example, if the bank deems that there is a 20% chance they will not get their money back, they must lend you the money at 25% APR in order to protect their risk
The problem is that 25% interest is considered usury in many states and is therefore illegal. To be able to lend to a small business at a more reasonable rate of 6% to 9%, the bank must be at least 95% sure that the loan will not default. Now do you see why it’s so difficult for small businesses to get loans?
While it may feel impossible, the fact is that some small businesses do receive bank loans. So what’s their secret? How does the bank achieve 95% certainty?
The banks arrive at this number by measuring different elements that contribute to default risk. Their goal is to make sure all signs point to the business succeeding and generating a reliable source of revenue.