Does a Business Loan Affect Personal Credit?
Have you reached the point in your entrepreneurial journey where you need extra funding?Before you apply for a loan, it’s important to understand how business lending can impact your personal credit. Depending on how your business is structured, business lending can affect your individual borrowing capacity, personal credit score, and more. Understanding how business lending impacts personal credit can help you make informed financial decisions.
The Difference Between Business and Personal CreditYour personal credit score is associated with your social security number and reflects your personal financial reliability. To calculate your score, credit bureaus consider payment history, credit utilization ratio, mix of credit products, and length of credit accounts. Your personal credit score is reviewed when you apply for a new personal credit card, housing, etc.
Business credit is an indication of a business’ creditworthiness and is usually connected to the company’s federal employee identification number (EIN). However, sole proprietorship entities that do not have any employees are not required to obtain an EIN; in these cases, the business owner’s social security number is associated with their personal and business credit.
Any time you apply for new financing for your business, your credit score will help determine the rates and loan terms you’re offered. A high credit score can help you secure low-cost lending with favorable interest rates, whereas a low score can make it harder to find reasonable financing.
When Does a Business Loan Affect Personal Credit?In most cases, lenders will require some form of collateral or personal guarantee before they agree to financing. A common myth is that only loans to startups or new businesses require personal guarantees , but personal guarantees are a standard practice in business lending. A personal guarantee can help businesses establish credit, secure better interest rates and loan terms, and qualify for lending they otherwise might not qualify for. However, personally guaranteeing a loan means the loan has the potential to impact your personal credit if the business can’t make the agreed upon payments.
If you are a sole proprietor without employees, your social security number will be used in place of an EIN. In this scenario, your personal credit is your business credit, so business financing would affect your personal credit in the same sense personal lending would.
When Do Business Loans Not Affect Personal Credit?Simply applying and obtaining a business loan shouldn’t impact your personal credit other than the soft inquiry at the time of application. Business loans do not typically show up on your personal credit report unless the bank reports it to credit bureaus as personal lending under your social security number. Normally, your personal credit report shouldn’t be impacted by a business loan, even if you’ve personally guaranteed the loan. Business debt and payment history do not affect your credit score, unless the business defaults on the loan, in which case your personal credit can be negatively impacted.
How a Business Loan Could Affect Personal CreditThe nature of business loans and their potential effect on your personal credit is largely dependent on how you structure your business. Registering your business as a sole proprietorship is more likely to affect your personal credit than if you were to register as a corporation or limited liability company. Additionally, securing a loan with a personal guarantee means you have personally promised to pay the loan back, even if the business defaults. When considering how a business loan could affect your personal credit, consider the following factors: business structure, loan composition, and how you resolve the default, if applicable.
Business StructureThere are several ways you can choose to structure your business; each structure comes with its own set of pros and cons. The business structure determines whether your personal credit is associated with your business. Consider consulting with an accountant; they can help you make an informed decision on which structure might be best for you.
- Sole Proprietorship: You are the sole owner of your company. This option offers you the most freedom and control as a business owner; however, structuring your business this way means your personal credit score will also be your business credit score, and if you don’t have any employees, all lending will be associated with your social security number as opposed to an EIN.
- Limited Liability Company (LLC): LLCs operate as separate legal entities, meaning the shareholder’s personal credit is not associated with the business. Unless shareholders personally guarantee the loan, they are not liable for the business’ debts. As a result, the business’ ability to repay debt will not reflect on a shareholder’s personal credit score. However, some lenders might review personal credit reports in addition to the business’ credit before making any lending decisions.
- Corporation: Like an LLC, corporations are separate legal entities and do not affect the personal credit of its shareholders. The business’ financial activity does not impact the business owner’s finances.
Loan StructureWhen you apply for business financing, lenders will likely look at your personal credit score and history to get a better overall understanding of your finances. Just because a lender looks at your credit score does not mean your personal credit will be affected. However, if you personally guarantee a loan, you are linking your personal credit with the business loan you’re obtaining. This means you will be responsible for making the payments if the business defaults on the loan.
How to Resolve the DefaultIn the event the business is not able to make payments as agreed, most banks will try to work out a repayment strategy with the borrower. The bank may offer to restructure the loan; some options include an interest-only period or extended amortization. If you have personally guaranteed the loan, your lender might move to collect any collateral you used to secure the loan (business or personal assets like equipment, vehicles, or buildings).
How a Personal Guarantee Can Affect Personal CreditIf you personally guarantee a business loan, your personal credit might be affected if your business defaults on the loan. A personal guarantee is your commitment to pay back any money borrowed by your company – meaning you’re personally responsible for repaying the debt if the business defaults.
When you personally guarantee a loan, your credit score is on the line. It’s critical you make regular, timely payments for the entirety of the repayment term, regardless of how the business performs. Defaulting on a business loan that you personally guaranteed can have a devastating affect on your credit score and prevent you from receiving both personal and business funding in the future.
How to Build Business CreditIn order to run a healthy, financially stable business, building up your business credit score should be top of mind. The earlier your business establishes credit, the greater your chances of securing finances on favorable terms. Registering your business, opening a business bank account, and opening/using a business credit card are a few steps to get you started. Click here for more tips on how to establish and maintain business credit.
Can Personal Debts Affect Business Loans?Personal debt might impact your ability to obtain a business loan if your business is structured as a sole proprietorship, your company has a low credit score, or if the lender requires a personal guarantee and you have a low personal credit score.
When you apply for a business loan, the ‘Five C’s of Credit’ is a common method lenders use to assess your risk as a lending candidate. Carrying excess personal debt in your name can limit or exhaust your borrowing capacity and can put your business at risk of default, making lenders less likely to offer you favorable financing terms.
How To Get a Business LoanIf you’re ready to take your business to the next level, we’re here to help. Check out your loan options or contact a banker today.
About the Author, Jessica Michener: Jessica Michener is the Director of SBA 7a Small Loans at SouthState Bank. She worked in Credit Administration for 15 years; she began her career as a credit analyst and then grew to manage a team of commercial loan underwriters. When the pandemic hit, she assumed a leadership role in the bank’s Paycheck Protection Program (PPP) efforts, which opened the door to SBA lending. After PPP, she led the charge to start the bank’s SBA 7a small loan department.