As a small business owner, the ability to obtain low-rate credit is critical to your business success. Unfortunately, many small business owners find that credit decisions for their business are based on their own personal credit, not simply on the creditworthiness of their business—even if the business is incorporated. This is a bigger problem for brand new businesses than it is for established ones, but even small businesses that have been successful for decades are often asked for personal guarantees and have business credit decisions based (at least partially) on the credit scores of their owners.
Your credit score, whether business or personal, is often the deciding factor for not only whether you are offered a loan, a line of credit, a payment processing merchant account, a business credit card, or even a lease, but also for the interest rate you are offered. Thus, a high credit score can in some cases make the difference between profitability and operating at a loss.
That’s why a recent announcement from FICO is good news for small business owners who have been impacted by less than optimal credit scores. According to the company, the FICO Score is utilized as part of 90% of all US consumer lending decisions. It is also widely used for small business lending decisions based on an owner’s personal credit.
The recently announced FICO® Score 9 is a change to the scoring algorithm that will likely result in higher credit scores for many individuals. The three main changes are:
- Unresolved medical debts that go to collections will now have far less impact on a consumer’s FICO score. If the only blemish on your credit is unpaid medical bills, your score will likely decrease by 25 points—far less than it would using the older models.
- You will no longer be penalized for bills that went to collections, as long as you settle them or pay them off. This means that if you had issues in the past, for whatever reason, but you have now rectified them, they will not continue to count against you. Estimates are that this change can raise FICO scores by 100 points or more.
- A new algorithm better designed to gauge the creditworthiness of those with limited credit history. Previously, having a “thin file” or little or no documented credit resulted in lower scores and being offered higher interest rates, which resulted in preventing people who never had credit from being able to afford it. The change is designed to break this vicious circle and better represent a credit applicant’s true risk profile.
Read this .inc analysis of the change for an in depth look, and some background on the studies that prompted FICO 9.
Of course, regardless of the model used to generate your credit score it will be based on the information provided in your credit reports themselves. (Remember, there is a difference between your credit report itself and your FICO score, which is based on those reports.) That’s why you should be certain to review your credit reports at least annually, and you should check your score periodically too. To get a free personal credit report from each of the three main credit bureaus, Experian, Equifax, and TransUnion, go to annualcreditreport.com. You can also check your small business credit report (but not for free). This Tip of the Week post from last December provides details on how to do this.
One more thing to note is that while the FICO score changes are likely to be welcomed by consumers, using the new FICO Score 9 is not mandated. Lenders can continue to use older scoring models, or models of their own. Estimates are that it may take over a year for a majority of lenders to adopt the new scoring. However, if you are denied credit or offered less than favorable rates for your small business, or for a personal loan, and you think you would benefit from being scored with FICO 9, be sure to ask your lender about it. Mention that FICO 9 was developed to generate a more accurate predictive analysis of credit risk than the older models, so it is in your lender’s best interest to use the best model available. It can’t hurt, and it could help quite a bit.
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