Do business loans use personal credit? Usually yes.
Unlike CEOs of large public companies, whose personal financial situation has little impact on their business borrowing, if you are a small business owner, your personal credit is a major factor influencing your access to capital. your business. There are many reasons why small business owner personal credit affects business loans. Access to the capital of their companies is linked to:
- The power of personal credit scores to predict small business loan repayments.
- The legal structure of many small businesses.
- Use by small business owners of personal guarantees and personal loans to finance their business activities.
Many lenders will look at your personal credit score if you are a small business owner looking for a business loan. A report prepared for the US Small Business Administration found that 71% of banks used small business owner credit scores when taking out small business loans.
Using homeowners’ personal credit scores makes sense. As researchers from the Federal Reserve Bank of Atlanta explain, the personal credit history of business owners is a good indicator of repayment of business loans under $ 100,000.
The legal structure of small businesses also links personal credit to business access to capital. About 72 percent of US businesses are sole proprietorships, according to data from the Internal Revenue Service. The debts of sole proprietorships are not legally distinct from those of their owners. Therefore, lenders and commercial creditors pay particular attention to the personal creditworthiness of sole proprietorships.
Even when small business owners set up companies to limit their personal liability for their business debt, they often tie their personal credit to their business borrowing. They do this by personally guaranteeing the debts of their businesses and by borrowing personally to finance the operations of their businesses. According to an analysis by the Federal Reserve, 41% of all small business loans and 56% of small business loans are personally guaranteed.
Studies show that many small business owners borrow personally to finance their business operations, further intermixing small business loans with homeowners’ personal credit. An article by Alicia Robb of the University of California at Santa Cruz and David Robinson of Duke University indicates that about a quarter of new companies are financed by personal loans from their founders.
For many small business owners, leveraging home equity is an important way to turn personal credit into business capital. Analysis by Barlow Research, a Minneapolis-based market research company, shows that about a quarter of small business owners use their home equity to fund their business. Homeowners do this either by using their home as collateral for business loans or by taking home equity loans and injecting the proceeds into their businesses.
Taking advantage of personal lines of credit from credit cards is another way small business owners use personal credit to finance their business operations. According to Intuit’s Future of Small Business Credit Report, small business owners have $ 150 billion in outstanding credit card debt that they used to fund their businesses.
As you can see, small business loans are very often based on personal credit. In addition, personal credit will affect the ability to obtain a business loan.