Could a business loan application affect your personal credit? Let’s take a look at the issue to see if you need to worry.
Perhaps you’re gearing up to expand your business. Or maybe you need a little extra cash to help you through a tough time.
Either way, you’re going to need to lodge business loan applications.
But you might feel anxious about one question:
Will a business loan affect personal credit?
You’ve heard horror stories about people destroying their credit score. Take Anna as an example:
Anna needed a loan to buy a few things for her business. She knew she had a solid credit score, so she started sending in applications.
Her intent was to find out which lender would offer a better deal.
She didn’t realise that each loan application placed a mark on her credit report. Her report now shows her as someone in financial distress, even though she’s only shopping around.
Now it’s even harder for her to secure any sort of loan.
Could the same thing happen to you? Business loans have the potential of affecting your personal credit, depending on the circumstances.
This article looks at how a business loan may affect your credit. It tells you what you need to know before you make a business loan application. Business loan applications can impact personal credit, so it’s important to understand not only the possible consequences for your credit score but also how a business loan may affect getting a mortgage.
Your business structure can also play a role in whether a business loan affects your personal credit.
Lenders Take All Credit Scores into Account
Let’s get one thing out of the way first. Lenders don’t just consider your business credit when checking your application. They’ll also take a look at your personal credit history.
That’s why it’s important to know the differences between a personal and business credit file.
A personal credit file contains information about any loan applications you’ve made. It also offers data about any loans or credit facilities you currently have active. This file alerts lenders to any judgements, missed payments, or other issues, too.
Your business credit file focuses specifically on your company. Other businesses may check this file to ensure you’re safe to do business with. Lenders will look at it to check your business’ financial health so they can ensure you’re safe to lend to. A strong business credit history is crucial for establishing your company’s creditworthiness, especially for startups and small businesses. Business credit scores are assessed separately from personal credit scores, but if your business lacks an established credit history, lenders may rely on your personal credit as a proxy. Lenders also consider your business’s creditworthiness as a key factor in their lending decisions. Additionally, a business’s revenue is an important indicator of financial health and loan eligibility.
Soft and Hard Inquiries
Let’s confront the key question:
Will a business loan affect my credit?
It may. It all comes down to the sorts of inquiries the lender runs during the application process. Credit applications for business loans can result in hard inquiries on your credit reports, which may impact your credit score.
The lender may use two types of inquiries – soft and hard.
Soft Inquiries
The good news about soft inquiries is that they don’t cause any negative issues with your credit score. At worst, they’re noted down as a request for access to your credit file. At least they leave no black marks, which means you don’t have to worry about Anna’s situation.
In fact, your business and personal credit scores may undergo soft inquiries several times per day. For example, a credit bureau will run this type of check if you ask to see your credit score.
Hard Inquiries
These are the ones you have to worry about.
A lender will run hard inquiries on both your personal and business credit files when you apply for a business loan. These are essentially the “official” version of a lender’s credit check. And they’re recorded on your credit files as such. This will affect your credit score.
A single application will have a minimal effect. However, opening new credit accounts or taking on new loans can reduce your available credit, which may influence your credit score. But as Anna discovered, having a lot of hard credit pulls recorded on your file over a short period of time can cause damage.
A hard credit inquiry will also show more details about your history. The lender will be able to see what loans you have and which lenders have refused your applications in the past. Multiple hard inquiries or excessive borrowing can have a negative impact on your credit profile.
The good news is that lenders can’t conduct this sort of inquiry without your permission. You have a measure of control you can use to prevent these inquiries from having a major effect.
Personal Guarantee and Credit History
When you apply for a business loan, lenders often require a personal guarantee—especially if you’re a small business owner, sole trader, or operating under a sole proprietorship. A personal guarantee means you’re personally responsible for repaying the business loan if your business can’t meet its obligations. This direct link between your business’s debts and your personal credit can have a significant impact on your personal credit score and credit history.
If your business defaults on the loan or misses payments, the lender can pursue your personal assets to recover the debt. More importantly, any late payments or defaults are likely to be reported to a credit reporting agency, which can negatively affect your personal credit file. This can lower your personal credit score, making it harder to qualify for personal loans, credit cards, a home loan, or even a car loan in the future. Lenders may view you as a higher risk, potentially leading to higher interest rates or less favorable loan terms on future credit products.
Many business owners don’t realize that signing a personal guarantee increases their personal responsibility for the business’s debts. This is especially true for sole traders and those running sole proprietorships, where there’s no legal separation between personal and business finances. If your business struggles with cash flow or can’t keep up with loan repayments, your personal credit can suffer the consequences.
To protect your personal credit score, it’s crucial to maintain a solid credit history before agreeing to a personal guarantee. Review all loan terms carefully, including repayment history and credit utilisation requirements, to ensure you can comfortably meet the loan repayments. Keeping your personal and business finances separate—such as maintaining a dedicated business credit file—can also help minimize the risk of negative effects on your personal credit.
Seeking professional advice before signing a personal guarantee is always a smart move. An expert can help you understand the full implications for your credit and guide you toward the best financing options for your business. In the intricate world of business loans, being proactive about your personal credit and understanding your responsibilities can help you avoid negative impacts and keep your credit rating healthy—no matter what challenges your business may face.
What Can You do to Minimise the Effects of Hard Inquiries
Here are a few things that will help you ensure your application doesn’t damage your personal and business credit:
- Don’t apply for several loans in a short period of time. This is the issue that caught Anna out. It can lead to lenders getting an inaccurate picture of your financial viability. Even if you have a clear track record of making repayments, too many applications can make it seem like you’re in distress. This makes you a risk, which leads to more rejections. And each rejection is another black mark on your credit score.
- Make sure you understand the lender’s exact requirements before submitting an application. Mistakes at this stage could lead to a hard inquiry without any need for it. You may get rejected because of the mistake, but that inquiry still sits on your record.
- Do whatever you can to improve your personal credit score before applying. Maintain a solid track record of on-time repayments and try to clear as many debts as possible. It may be worth holding off on your application for a few months if you need to clear up your credit rating. A strong payment history and making timely payments are crucial for improving your creditworthiness and increasing your chances of loan approval.
- Try to maintain low balances on any company credit cards or lines of credit. This will show the lender that your business uses the money it borrows responsibly. Managing business debts carefully can also help protect your personal credit, especially if your finances are closely linked.
Personal guarantees and personally guaranteed loans can increase your personal financial risk, particularly for small business owners and small businesses, as you become personally responsible for repayment if the business defaults. Establishing your business as a separate legal entity, such as an LLC or corporation, can help protect your personal finances from business liabilities. Securing loans with business assets (secure loans) can also reduce the risk to your personal credit. Maintaining access to working capital is essential for business growth, and positive credit management can improve your ability to obtain it. When lending money, lenders will consider your payment history and your ability to repay before approving financing for your business.
The idea is to present a healthy credit score, both personal and business, to show the lender you’re not a risk.
Check Your Credit Before Applying
Unfortunately, a business loan could affect your personal credit score. Specifically, applying before you’re ready could lead to a refusal. That would cause your score to drop. Applying for too many business loans in a short period can also have negative effects.
That’s why it’s so important to check your credit and prepare properly before applying. You might also consider alternatives to business loans, such as using personal credit cards, but be aware that this can impact your personal credit report.
When you feel like you’re ready, get in touch with us at Unsecured Finance Australia. We offer unsecured business loans of up to $300,000 and you can apply in a matter of minutes.
Seeking expert guidance can help you navigate the business loan process and protect your credit.
Apply online today to find out if you qualify for a loan.
