As you grow your business and seek financing opportunities, you may wonder if taking out a business loan could affect your personal finances. In other words, could a loan for your business have an impact on your personal credit score?
The answer is, yes, in some cases, it could. A business loan may impact your personal credit score if you run a sole proprietorship or partnership, or if you personally guarantee the business account in any capacity.
Read on to learn the different ways in which a business loan can affect your credit scores, and what you can do to keep business financing separate from your personal finances.
What Is Business Credit?
Business credit is based on your business’s credit history and is expressed in the form of business credit scores. Both your business credit profile and business credit scores give credit agencies, lenders, vendors, and suppliers an indication of how you handle your debts and your likelihood of paying them on time. Building your business credit profile can pay off by giving you access to small business loans and other types of financing with favorable rates and terms.
How Does Business Credit Work?
In order to establish credit for your business, you need to first legally register it as a business entity. Once your business is registered, your business credit reports will be created when vendors, suppliers, or creditors report your company’s accounts and activity to a business credit bureau. This activity helps to generate the information that informs your business credit scores.
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Difference Between Personal and Business Credit
While business and personal credit are two separate entities, the lines can sometimes get blurred.
Your personal credit score is linked to you through your social security number and uses information drawn from your personal credit reports. Your score reflects your funding and payment history, such as your use of credit cards or your record of paying off a student or personal loan, and can affect your access to future credit and what interest rates you pay. It may also be looked at by landlords and potential employers.
A business can have its own credit score, so long as it is a separate legal entity with a federal employer identification number (EIN). If you’re trying to get a business loan, some lenders may examine only your business credit history, which is reported by three major business credit bureaus: Experian, Equifax, and Dun & Bradstreet. Others may look at both your business and personal credit scores.
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What Types of Business Activities Can Affect Personal Credit?
In some cases, your business credit can affect your personal credit. Let’s take a closer look.
Business Credit Card Use
When you apply for a business credit card, the lender will typically perform a hard credit inquiry into your personal credit. Any hard credit pull can potentially lower your personal credit score by a few points, so you may see a small, temporary dip in your personal credit scores.
Once you’re using your business credit card, some activities will impact only your business credit, while others may affect both personal and business credit scores. It all depends on what the credit card issuer chooses to report and which credit agencies they choose to report to.
Some business credit card issuers report all of your account activity to the three major consumer credit bureaus (TransUnion, Equifax and Experian), while others will only report negative information to those bureaus, such as being more than 30 days late on a payment.
Most Business Debt
Any type of business loan could impact your personal credit if you personally guarantee the business account or your social security number is linked to the debt. The lender will likely report a defaulted business loan to both the business and consumer credit bureaus in these cases.
How Can Business Loans Affect Personal Credit?
A business loan can affect your personal credit score in a variety of different situations.
If your business doesn’t have an EIN and the loan is tied to your social security number, for example, you would be personally liable for any debts if your business fails and is unable to repay them.Failure to make timely payments would affect your personal credit score.
Another scenario in which business loans can affect personal credit scores is when the borrower signs a personal guarantee. With a signed personal guarantee, both your credit score and your business’s credit score may be affected by missing payments. A personal guarantee also puts your personal assets at risk.
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5 Ways to Protect Personal Finances From Business Debt
If you’d prefer to keep your personal credit score separate from any business debts you incur, there are some actions you can take to help make that happen. Below are some options you may want to look into.
1. Select the Right Business Structure
How your business is structured affects how banks and lenders interact with you. For example, if you’re a sole proprietor, it’s your name that will appear on every debt owed by your business, and your business and personal credit will be one and the same. Thus any late payments and defaults you accrue can have a negative effect on your personal finances.
If you want to sever ties, you would need to become a Limited Liability Company (LLC), S-corporation, or C-corporation. Each set-up comes with a unique set of tax burdens and benefits, so when choosing a business structure, it can be a good idea to consult with a tax professional or business organization lawyer.
2. Open a Business Bank Account
Establishing a separate bank account for your business bank is one of the most important steps you can take to keep your company’s finances separate from your own. When looking for the right bank to open a business checking account, you’ll want to consider services you need now and might need in the future (such cash flow management tools or merchant services), as well as fees for business accounts (which can be different from fees for personal accounts). Also check the documentation requirements for opening a business bank account.
3. Consider Getting a Business Credit Card
It can be hard to get a business credit card right out the gate, which is why many business owners need to sign a personal guarantee when getting one.
However, you may be able to find a business credit card that does not routinely report activity to the consumer credit reporting agents. Keep in mind, though, that you need to make all payments on time. Most major small business cards will report if you default on the card.
Another option may be to get a secured business credit card. A secured card uses money that you yourself deposit as collateral. This refundable deposit protects the card issuer in case of default.
Like a regular credit card, you make payments on any amount you use each month. After your business has proven to be financially responsible, you can request to upgrade to an unsecured business credit card.
4. Understand How Defaults Are Resolved
How a default is handled will depend on how the loan was set up. If you personally guaranteed the loan, your lender may collect any collateral you put up to secure the loan, meaning you could lose your car or house. Likewise, all missed payments will show up in your personal payment history, which can lower your credit score and make it harder for you to get a personal loan or credit card.
If you or your partners did not personally guarantee the loan, then the business itself may be sued, and any business assets you used to secure the loan might be seized. You can also expect fees, interest, and penalties to accumulate, as well as your business’s credit score to take a hit.
5. Communicate With Your Lender
When applying for a business loan, it can be a good idea to ask the lender whether it will look at your personal credit report and score before approving you for the loan. If so, this means the lender will be doing a hard credit check on your financial history, which could temporarily lower your score by several points.
It can also be smart to review any documents and contracts that accompany the business loan. If any of them request a personal guarantee and require your signature instead of your business’s, then you know you will be held personally liable for the loan or line of credit.
You may be able to challenge the personal guarantee, but if you do, the lender may deny your loan request or increase your interest rate, meaning you’ll pay more for the same product.
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Personal Finances Affecting Business Loans
There are three scenarios where your personal finances might impact your ability to get a small business loan:
1. Your business is structured as a sole proprietorship or partnership.
2. Your business has a limited credit history.
3. Your business has a low credit score.
If any of the above are true, the following may impact your ability to get a loan or your loan terms:
Personal Credit Score
If your personal credit score is low, it can have a negative impact on your business loan. It may not prevent you from getting approved, but it could keep you from getting strong loan terms.
Personal Debt
Personal debt also has the potential to lower your prospects for being granted a business loan. If you have a lot of debt in your name, it may give lenders enough of a reason to charge you high interest rates, fearing you may one day default on payments.
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The Takeaway
Whether a business loan affects your personal credit depends on a few factors, including the type of loan you’re applying for, how you’re obtaining the credit, and your business structure.
Applying for a business credit card can lead to a small hit to your personal credit score because of the hard inquiry from the lender. If you personally guarantee a business loan, your personal credit can also be affected. Finally, if you run a sole proprietorship or partnership, your personal credit could be affected by a business loan if you put your name on the loan documents.
However, business debts don’t impact personal credit if the company and the owner are two separate legal entities and the loan isn’t connected to your name or social security number.
If you’re seeking financing for your business, SoFi can help. On SoFi’s marketplace, you can shop top providers today to access the capital you need. Find a personalized business financing option today in minutes.
FAQ
Are business loans based on personal credit?
In some cases, yes. A business loan will likely be based on your personal credit if your company is structured as a sole proprietor or partnership, or if your business’s credit history is thin or your business has a low credit score.
Do small business lenders check personal credit?
In some cases, yes. Lenders will likely check your personal credit if your business doesn’t have an Employer Identification Number (EIN), meaning the loan will be in your name, or if your business is new or has a low credit score.
Can a business loan affect getting a mortgage?
If your name is attached to the business loan in any way, then yes, it can affect your ability to get a mortgage.
When applying for a mortgage, your lender will likely look at your debt-to-income ratio. Your business loan (and any other debt you already have) combined with a new mortgage could potentially push you past the threshold that lenders like to see.
If your business is a separate entity, then a business loan will not likely impact your ability to get a mortgage.
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