Insights into the world of small business lending and development

Finance 101: Understanding the building blocks of good credit

Finance 101: Understanding the building blocks of good credit

This is the fifth post in a series on the basics of small business finances. Check out our posts on small business bank accountssmall business credit cardsaccounting software and building wealth. Stay tuned for future posts in this series.

After setting up the basics of your small business finances, like opening a business banking account or choosing an accounting system, you may be thinking about taking out a loan. Unfortunately, most banks view small business loans as a risky investment. One way to boost your chances of securing funding is by learning what lenders will consider when reviewing your application. Lenders use the “5 Cs of credit” to measure your “creditworthiness” and your ability to repay a loan. These considerations help them gauge how good of a borrower you’ll be and whether you are a sound investment. Check out the chart below to learn more about what lenders look for and how you can strengthen your application.

The “5 Cs of Credit:”

  1. The first C is character: Character is a lender’s opinion of how trustworthy and reliable you are. Lenders will use your credit history to see if you have a good track record of repaying debt.
  2. Capacity/Cash flow: Lenders are looking at your capacity or cash flow to make sure you have the money to repay the loan, plus interest.
  3. Capital: Capital is how much of your own money you’ve invested in your business, or how much “skin in the game” you have. Capital shows a lender your level of dedication and commitment to your business.
  4. Collateral: Collateral refers to property or assets that can be pledged as security like real estate, equipment or cars. By putting up collateral, your lender has the right to seize your property if you default.
  5. The last C is Conditions: Lenders will consider outside factors that could hit your business, such as economic or industry factors.

Your credit score is an important part of seeking any type of credit, including a loan, as part of the “character” consideration. Five factors help explain how credit agencies evaluate the information in your credit reports when calculating your personal credit score. The better your score on each of these factors, the higher your overall credit score. These five main factors include:

  • Payment History (35% of score): Pay bills and debt payments on time to improve your payment history score.
  • Debt Utilization (30% of score): Maintain low balances on your credit cards and lines of credit. Generally, you should not exceed using more than 25-30% of your available credit.

  • Credit History/Age (15%): If you have a short credit history, you can improve your score by building credit to demonstrate responsible financial behavior.

  • Credit Inquiries/New Credit Checks (10% of score): Too many applications for credit and new credit accounts can bring your score down.

  • Types of Credit (10%): A mix of different types of credit accounts can help boost your score. Resource Locator Map to find lenders or business assistance providers near you that can advise you on how to build your credit.

Finally, if you are worried about your credit history, you might be tempted to take advantage of financing offered through online lenders. While some of these new players do offer options for borrowers with non-traditional credit histories, you should be wary of predatory lending practices. Some of these online lenders may hide the true terms and costs of the loan, for example charging significant fees if you try to pay some of the balance in advance. Learn more about responsible lending before you decide to work with an online lender.

Now that you know what lenders look for and the key factors in determining your credit score, get educated about your credit history. You can check your credit score for free through our partners at Nav.com at www.nav.com/sbm.

 

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