Understanding Personal & Business Credit
When it comes to managing your finances, understanding the difference between personal and business credit can help you make informed decisions about your business and ensure that you are making the best use of your resources. Good personal and business credit scores are vital for any small business owner to access the financing they need. In this blog, we walk you through some of the key differences between personal and business credit, how they’re calculated, and what types of credit exist.
Personal Credit vs. Business Credit
Personal credit is a measure of an individual’s ability to borrow money and repay it. It is based on a person’s credit history and other factors such as income, employment, debt, and financial behavior. Good personal credit can open doors to financial opportunities such as car loans, mortgages, and credit cards.
On the other hand, business credit is a separate entity from personal credit and is often needed to obtain business financing. Businesses can then use the financing to grow by purchasing goods and services, financing expansion projects, boosting cash flow, etc.
Separating Personal Credit from Business Credit
First, establishing a business credit profile is an essential step for any small business owner. Opening a business checking account is usually a good place to start. When your personal and business finances are tied to the same account, maintaining a good personal credit score becomes extremely challenging. Having a separate account for your business will prevent you from paying business expenses with personal funds or credit cards.
Opening a business account has numerous advantages, including:
Understanding Credit Scores
Personal and business credit scores are calculated using the same principle: they’re a snapshot of your past borrowing habits and ability to pay back debt. Both scores are evaluated and maintained by two main credit bureaus:?Equifax?and?TransUnion.?For business credit reporting, there is also a third one,?Dun & Bradstreet.?There’s a lot that goes into calculating your scores, but simply put, the higher your score, the less risky you are to lenders.
All lenders have their own unique models and consider different factors when evaluating creditworthiness. For example, unlike traditional banks that rely heavily on credit scores and collateral,?OnDeck Canada?uses a combination of technology and real people to determine your business’s overall financial health.
What Goes into Calculating your Personal Credit Score:
Your personal credit score is a number between 300 and 900 – anything above 760 is considered excellent. Several factors go into calculating your personal credit score such as:
1. Paying Bills on Time:?Payment history is one of the most important factors in your credit score. A history of timely payments will positively impact your score.
2. Credit Utilization:?The amount of credit you are using compared to the amount of credit you have available. It is important to keep your?credit utilization?A good rule of thumb is to keep your utilization below 30%.
3. Credit Mix:?Bureaus believe a mix of different types of credit, such as revolving credit (e.g., credit cards) and installment credit (e.g., mortgages) is important. It shows that you can handle different types of credit responsibly.
4. Credit History:?The longer your credit history, the better. A long credit history allows bureaus to know how you have handled credit over time.
5. Credit Inquiries:?Simply put, a?credit inquiry?is a credit check made by lenders when you apply for new credit. Generally speaking, inquiries can hurt your credit score. To avoid this, only apply for new credit when you are ready to use it.
What Goes into Calculating your Business Credit Score:
With business credit, things are a little more complicated. Credit bureaus use different methods of calculating your score, which means that your business will have multiple scores. To make matters more confusing, each bureau has different types of credit scores. For Instance,?Equifax?establishes four scores:
Safe to say, there’s no standard scoring model for assessing business credit risk. Bureaus have different approaches to telling the story of your financial health. Here are some of the major factors they consider:
1. Payment History:?Like your personal credit score, the most important factor that makes up your business credit score is your payment history. Bureaus want to see that you have a good track record when it comes to repaying debts.
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2. Company Size & History:?Bureaus consider how long your business has been around and how many employees you currently have on staff. A longer company history usually means a higher score.
3. Industry: The type of industry you’re in may further influence your score. For example, if your industry has a higher risk of failure, it may hurt your business score.
4. Debt & Debt Usage:?Credit bureaus consider how much outstanding debt your business has and how that debt is being used towards your business.
Types of Personal Credit & Business Credit
With all the credit options that exist, it is essential to choose the type of credit that best suits your individual needs and goals. Let’s look at some of the different types of personal and business credit available to borrowers.
Personal Credit:
1. Revolving Credit
Revolving credit,?such as credit cards, allows you to borrow up to a maximum limit and make payments as you go. This type of credit makes it easier to manage your finances, as you can borrow what you need and make payments against the balance over time. The goal is to pay off the amount owed in full each month, so it is important to consider carefully how much credit you can realistically afford.
2. Open Credit
Open credit?is a type of revolving credit, where you can borrow up to a certain limit and continue to borrow as needed. Open credit can offer flexibility when it comes to borrowing money, but it can also come with high-interest rates if you are not careful. For example, utility bills, like gas, electricity, water, cable, and cell service are considered open credit accounts.
3. Installment Credit
Installment credit?allows you to borrow a set amount and pay it back over time with interest in regular fixed payments or installments. Installment credit is usually used for auto loans, mortgages, or personal loans.
Business Credit:
1. Charge Cards
Charge cards?are a type of business credit that allows businesses to pay for goods and services using a card. Unlike traditional credit cards, charge cards require the full balance to be paid off each month. Charge cards can be a great way for businesses to make large purchases, as they often come with a higher credit limit than regular credit cards. They also provide businesses with the flexibility to make payments in installments or as needed.
2. Revolving Credit Accounts
Revolving credit accounts,?such as business credit cards, is a type of credit that allows you to borrow money up to a certain limit and then repay it over time. They offer flexibility and can be a good option for businesses that need to make small purchases or that have irregular cash flow. However, they also have high-interest rates and can be difficult to get if you have bad credit.
3. Installment Credit Accounts
Installment credit,?such as?fixed-term loans,?is a type of credit that allows you to borrow a fixed amount of money that you can use for a specific purpose. You will have to make regular payments over a set period, and the interest rate will be fixed. Installment credit can be a good option for businesses that need to borrow a large amount of money for a specific project.
4. Vendor Credit Accounts
Vendor credit accounts?are a type of business credit that is available to businesses that purchase goods or services from their suppliers. The supplier will offer the company a line of credit, allowing the business to purchase goods and services without having to pay upfront. The supplier then bills the company for the goods or services purchased, and the company pays them back over time. Vendor credit accounts are beneficial for both the business and the supplier, as it allows for more convenient purchasing and more predictable cash flow for both parties. These accounts are commonly called net-30 accounts, which means you have 30 days to repay the credit line.
Conclusion
Both your personal and business credit scores matter as a business owner. Some lenders weigh personal and business credit scores equally, others look solely at your business’s creditworthiness, and some have their own unique models that take multiple factors into consideration. It’s important to separate and keep track of both these scores, as you’re more likely to get approved for financing with favorable terms such as lower interest rates, longer repayment periods, higher loan amounts, or larger lines of credit.