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It’s All About the Score
There is a direct correlation between managing your personal finances well and your success to meet the capital & credit needs of your business. Many small business owners I speak with don’t quite understand why they must personally guarantee a business loan. The personal guarantee process involves the lender checking your personal credit report and score and usually, the business owner must sign an agreement. Since many small business owners don’t have a well established business credit profile, personal credit acts as a reference for a small business owner. Lenders will use your personal credit profile to determine the likelihood of you repaying a loan as expected – especially if the loan is unsecured. The Fair Credit Reporting Act (FCRA) allow lenders to review for business lending purposes the personal credit history of a sole proprietor and a partner in a partnership.                 

.The use of credit scoring makes the credit granting process much more expeditious. But while lenders applaud the benefits, many small business owners find it difficult trying to manage all the different consumer 3-digit numbers, and, rightfully so.

Fair Isaac Corporation, the pioneer in credit scoring, developed the FICO® credit score. They have a scoring model with a range of 300 (very poor) - 850 (excellent). Most lending industries use a variation of the Classic FICO® Score as their model. Each credit bureau has a different name for their Classic FICO® Score. The Experian credit score is called Experian/FairIsaac Risk Model, Transunion score is called FICO® Risk Score, Classic and Equifax score is called Beacon. 

All credit scores are not equal. Depending on the type of credit you apply for - a business loan, mortgage, personal loan, auto loan or credit card, for example - lenders use different credit score formulas. Business loan payments, for example, weigh more heavily in the formula that calculates a FICO® score for business lenders, while credit-card payments matter more to the FICO® score used by credit-card companies.

Credit bureaus collect data independently of each other and they typically don’t share it. Each credit bureau calculates your credit score with the data in its file.  So, if you have a collection account that appears on your Equifax credit report, but not on your Transunion credit report, then your Equifax score might be lower. This is why it’s important to order all 3 credit reports and complete a detailed review. You can order Equifax, Experian and Transunion for free annually at annualcreditreport.com or call 877.322.8228. 

 Fair Isaac introduced a new version of its FICO® score analysis in 2008 called FICO®  08 score. This scoring model will be more forgiving to someone that is in arrears in one area, but have a number of other accounts that are in good standing. Some lenders will use the new score model, however, others will continue to use the old model - Classic FICO® Score.  Then there’s the VantageScore developed by the three major credit bureaus. This score ranges from 501- 990 and assigns letter grades (A to F) to specific score ranges. At this time, very few lenders use VantageScore.

 

While all credit scores are calculated using the information in your credit report, the formulas used are slightly different, and in some cases, so are the scoring ranges. So if you’re working on improving your credit, a smart credit move would be to use the FICO® score as your basis and to focus on increasing this score. Go to the Fair Isaac’s consumer site at myfico.com to find out what your baseline score is. If a lender comes up with a substantially different score, you will at least have a starting point for asking questions.  Ask a potential lender which scoring model they use and how you can get your score to meet their standards in order to qualify for a loan. For example: If you apply for an auto loan, and your past auto loans have been paid on time, your auto-loan FICO®  score will reward you for those on-time payments. But if you've had late payments on an auto loan or a car repossession, your auto score will suffer more than your traditional score. The other components that make up your auto-loan score are pretty much the same as those that make up your traditional score. Those include your repayment history, the amount of credit you use relative to your limits, the length of your credit history, your mix of credit and new credit.

 

What you should focus on:

 ·    Pay all your bills on time. That’s 35 percent of your FICO® score.

·    Keep a low debt–to-credit limit ratio. That’s 30 percent of your FICO®  score.  

·    Don’t apply for too much credit at a time. 

That’s 10% of your FICO® score. The bottom line, make sure your personal credit report doesn’t cause a credit breakdown for your business.

Lathea Morris is a Principal of MorlinoandLathea.com. She presents small business training programs and coaches business owner on improving their credit score. Also, she is a co-founder of The Credit Alternative Group, a financial products company. She co-created The Complete Credit Management Toolkit© 3.0.

 

 

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