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Apr 28, 2023
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Last update: May 17, 2024

The Impact of Business Debt on Your Credit Score: What You Need to Know

Business debt is an essential aspect of running a successful enterprise, but it’s important to understand how it can impact your credit score. Your credit score is a key factor in determining your eligibility for small business loans, line of credit, SBA 7(a) loans and other financial products.

As a business owner, knowing the relationship between business debt and your credit score will help you make informed decisions to ensure your business’s financial health and your own personal financial stability.

Business Credit Score vs Personal Credit Score

While both business credit scores and personal credit scores evaluate creditworthiness, they differ in several key ways. 

But first, make sure you know how to properly check your FICO credit score!

A business credit score represents the creditworthiness of a company, and credit bureaus calculate it based on the business’s financial history. Factors affecting business credit scores include payment history, outstanding debt, length of credit history, and public records, such as bankruptcies or liens. A strong business credit score can help a company secure better interest rates, loan terms, and trade credit from suppliers.

A personal credit score, on the other hand, represents an individual’s creditworthiness. Credit bureaus calculate personal credit scores based on factors such as payment history, credit utilization (the ratio of credit used to available credit), length of credit history, types of credit, and recent credit inquiries.

A strong personal credit score can help individuals secure better interest rates on loans, credit cards, and even impact their ability to rent an apartment or secure a job.

While these two types of credit scores are distinct, it’s essential to recognize that, as a business owner, your personal credit score can impact your business’s ability to secure loans and credit, especially for small businesses and startups. 

Certain types of business debt, such as personally guaranteed loans or business line of credit, can affect your personal credit score. Understanding the factors affecting each type of credit score can help you make better financial decisions for your business and personal finances.

Types of Business Debt that Can Impact Your Personal Credit Score

There are several types of business debt that can have a direct effect on your personal credit score. These include:

  • Personal guarantees: A personal guarantee is a promise made by a business owner to repay a business loan if the business defaults. If you’ve provided a personal guarantee for a business loan, and the business is unable to repay the debt, you will be held responsible for the remaining balance. In this situation, any late payments or defaults can negatively impact your personal credit score.
  • Business credit cards: Many business credit cards report activity to the personal credit bureaus, which means that your personal credit score can be affected by the usage of these cards. Late payments, high balances, and maxed-out credit limits on business credit cards can all contribute to a lower personal credit score.
  • Jointly owned business debt: If you share responsibility for business debt with another individual, both of your personal credit scores can be affected by the management of that debt. Late payments or defaults on jointly owned business debt will have a negative impact on the personal credit scores of all parties involved.

How Business Debt Affects Your Credit Score in Different Industries?

Business debt can impact your personal credit score in several ways, and this impact can vary depending on the industry your business operates in. For instance, businesses in the dispensary, HVAC, or manufacturing sectors might have unique funding requirements and challenges. Regardless of the industry, it’s crucial to understand how business debt affects your credit score.

Payment History

Your payment history accounts for the largest portion of your personal credit score. Late or missed payments on business debt, particularly for debts with personal guarantees or jointly owned debts, can lead to a lower personal credit score.

Credit Utilization

Credit utilization refers to the ratio of your outstanding credit balances to your total available credit. High balances on business credit cards, for example, can increase your credit utilization ratio, resulting in a lower personal credit score.

To maintain a healthy credit score, it’s important to keep your credit utilization below 30%, regardless of whether you’re using credit for dispensary funding, HVAC funding, construction business loans or manufacturing financing.

Length of Credit History

Opening new business credit accounts can impact the average age of your credit accounts, which is a factor in calculating your personal credit score.

A shorter credit history can lead to a lower credit score, so it’s important to be strategic about opening new credit accounts for your business, whether it’s for a cannabis-related business, veterinarian services, or construction financing operations.

Strategies to Minimize the Impact of Business Debt on Your Credit Score

To protect your FICO score from the potential negative effects of business debt, consider following strategies:

Separating personal and business finances: 

Establish separate bank accounts and credit cards for your personal and business finances. This will help you keep track of your expenses more effectively and minimize the chances of business debt impacting your personal credit score.

Timely repayment of business debts

Ensure you make all your business debt payments on time. By doing so, you can avoid negative marks on your personal credit report, especially for debts with personal guarantees or jointly owned debts. Consider using debt repayment strategies like the Debt Snowball or Debt Avalanche methods to help you stay on track with your payments.

Monitoring your personal and business credit scores regularly: 

Regularly reviewing your credit reports and scores can help you identify any errors or discrepancies, as well as track your progress. By monitoring both your personal and business credit scores, you can take proactive steps to maintain a healthy credit profile.

Building a strong business credit profile:

By building a strong business credit profile, you can reduce your reliance on personal guarantees and minimize the impact of business debt on your personal credit score. To build business credit, ensure you have a registered business entity, obtain an Employer Identification Number (EIN), and establish trade credit with suppliers.

Repairing Your Credit Score After Business Debt Issues

If you’ve experienced business debt issues that have negatively impacted your personal credit score, there are steps you can take to repair your credit.

Focus on paying down your outstanding debts, maintaining a low credit utilization ratio, and avoiding late payments. Additionally, diversify your credit mix by responsibly using different types of credit, such as installment loans and credit cards.

Importance of working with creditors and credit bureaus to resolve inaccuracies

Review your credit report for errors or discrepancies, and promptly dispute any inaccuracies with the credit bureaus. Work with your creditors to negotiate payment plans or settlements for outstanding debts, which can help improve your credit score over time.

Establishing a long-term plan for credit score improvement 

Develop a comprehensive plan to improve your credit score, including setting realistic financial goals, creating a budget, and regularly monitoring your credit progress. By committing to a long-term plan for credit score improvement, you can rebuild your personal credit profile and ensure future financial success for both you and your business.

The Importance of a Healthy Debt-to-Income Ratio

Understanding the importance of maintaining a healthy debt-to-income (DTI) ratio can help business owners better manage their business debt and personal finances. A lower DTI ratio makes it easier for individuals to qualify for loans and receive better interest rates.

Here are some examples of how to maintain a favorable DTI ratio:

  1.     Prioritize high-interest debts: Focus on paying off high-interest debts first, such as credit card balances or personal loans with steep interest rates. By tackling these debts first, you can save money on interest payments and reduce your overall debt more quickly.
  2.     Create and stick to a budget: Developing a comprehensive budget can help you track and control your personal expenses. By reducing unnecessary spending and allocating more funds towards debt repayment, you can improve your DTI ratio over time.
  3.     Refinance existing loans: If you have loans with high interest rates, consider refinancing them to secure lower interest rates and more favorable terms. This can help reduce your monthly payments and improve your DTI ratio.
  4.     Increase your income: Boosting your income, either through a raise, a side hustle, or by expanding your business, can improve your DTI ratio by increasing the amount of money you have available to pay off debts.
  5.     Avoid taking on new debt: Be cautious when considering new loans or lines of credit, as these can increase your overall debt and negatively impact your DTI ratio. Only take on new debt when it’s necessary and financially beneficial.

By paying off high-interest debts first and keeping your personal expenses in check, you can maintain a favorable DTI ratio, which is essential for securing loans and maintaining your financial health.

Bankruptcy and Its Impact on Credit Scores

In some cases, business owners may need to consider bankruptcy as a last resort for managing overwhelming business debt. It’s crucial to understand the different types of bankruptcy, their implications for your business and personal FICO score, and the long-term effects on your financial health.

Types of Bankruptcy for Businesses

There are several types of bankruptcy that businesses can file, each with its own set of requirements and implications:

  1. Chapter 7 Bankruptcy: This type of bankruptcy, also known as “liquidation,” involves the sale of a business’s assets to pay off outstanding debts. In most cases, the business ceases operations, and the owners may be held personally responsible for any remaining debt.
  2. Chapter 11 Bankruptcy: Chapter 11, or “reorganization,” allows businesses to restructure their debts and develop a repayment plan while continuing to operate. This option is more suitable for larger businesses with substantial assets and a viable path to profitability.
  3. Chapter 13 Bankruptcy: This type of bankruptcy is typically reserved for sole proprietorships, where the business owner’s personal and business finances are intertwined. Chapter 13 allows the business owner to restructure their debts into a repayment plan, typically lasting three to five years.

Impact of Bankruptcy on Personal and Business Credit Scores

Filing for bankruptcy can have significant consequences for both personal and business credit scores:

  1. Personal credit score: Depending on the type of bankruptcy filed and the business structure, your personal credit score may be significantly impacted. Bankruptcy remains on your personal credit report for 7-10 years, making it more difficult to obtain loans or credit in the future.
  2. Business credit score: A bankruptcy filing will also negatively impact your business credit score, potentially making it harder to secure financing, negotiate favorable payment terms with suppliers, or obtain business insurance.

Long-Term Effects of Bankruptcy on Financial Health

Bankruptcy can have lasting effects on your financial health and should be considered only as a last resort:

  1. Difficulty obtaining credit: With a bankruptcy on your credit report, it may be challenging to secure loans, credit cards, or other financial products for your business or personal needs.
  2. Higher interest rates: If you’re able to obtain credit after bankruptcy, you may face higher interest rates due to the perceived risk associated with your financial history.
  3. Stigma and reputation: Filing for bankruptcy can impact your business’s reputation and potentially affect your relationships with suppliers, customers, and partners.

Considering Alternatives to Bankruptcy

Before considering bankruptcy, it’s important to explore all other options and consult with a bankruptcy attorney to ensure you’re making the best decision for your situation. Some alternatives to bankruptcy include:

  1. Debt negotiation: Work with your creditors to negotiate more favorable payment terms or a reduced debt balance.
  2. Debt consolidation: Consolidate your debts into a single loan with a lower interest rate, making it easier to manage your monthly payments.
  3. Financial counseling: Seek advice from a financial counselor or credit counseling agency to help you develop a plan to address your debt and improve your financial situation.

Utilizing Business Debt Consolidation and Debt Repayment Strategies

Business debt consolidation can be a useful strategy for managing multiple debts and minimizing the impact on your personal credit score. By consolidating your debts into a single loan with a lower interest rate, you can simplify your monthly payments and potentially save on interest expenses. To effectively utilize business debt consolidation and manage your debt repayments, consider the following steps and strategies:

Assess Your Current Debts

Make a list of all your outstanding business debts, including their interest rates, balances, and payment terms. This will help you determine if debt consolidation is a viable option for your financial situation.

Shop Around for the Best Consolidation Loan

Research various lenders and compare their interest rates, terms, and fees. Look for a consolidation loan with a lower interest rate than the average of your current debts, as this can help you save on interest expenses.

Evaluate the Loan Terms

Carefully review the terms and conditions of any potential debt consolidation loan, paying particular attention to the repayment period, prepayment penalties, and any additional fees. Longer repayment periods may result in lower monthly payments but can increase the total amount of interest paid over time.

Consider Debt Repayment Strategies: Debt Snowball and Debt Avalanche Methods

  1. Debt Snowball Method: This approach involves paying off your debts in order of the smallest balance to the largest, regardless of the interest rates. As you pay off each debt, you “snowball” the payments from the paid-off debts into the next smallest debt, accelerating the repayment process.
  2. Debt Avalanche Method: With this method, you focus on paying off your debts in order of the highest interest rate to the lowest. By tackling the highest-interest debts first, you can save on interest expenses and potentially pay off your debts faster.

Choose the strategy that works best for your financial situation and motivation style by comparing debt snowball vs debt avalanche methods.

Consider the Impact on Your FICO Credit Score

While debt consolidation can simplify your monthly payments and potentially save you money, it’s important to understand how it may impact your personal credit score. Opening a new loan account can temporarily lower your FICO credit score, but making on-time payments and reducing your credit utilization can lead to long-term improvements.

Maintain Responsible Debt Management Habits

Once you’ve consolidated your debts, it’s crucial to continue practicing responsible debt management. Create a budget to track your expenses, avoid taking on additional debt, and prioritize making on-time payments to protect and improve bad credit score and financial health.

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