Credit Score for Business Loans
Though a humble three-digit number, a credit score mirrors creditworthiness. A credit score is an economic report card reflecting an individual or business's reliability with money and if they can manage their money well. These scores play a crucial role in determining loan eligibility for business financing.
The Confederation of Indian Industry (CII) conducted a survey in 2022. As per the report, approximately 63% of small and medium-sized enterprises (SMEs) reported that access to timely and affordable business loans remains a significant challenge due to low credit scores.
The Importance of Credit Score in Business Loans
A credit score reflects various financial factors like credit history, payment behaviour, length of credit, types of credit used, and amounts owed. Typically ranging from 300 to 900, higher scores indicate better terms and conditions for loans.
Credit scores are vital for business loans as they provide lenders with a measure to know whether money should be loaned out to you or not. It helps lenders swiftly evaluate the likelihood of borrowers repaying their loans as agreed.
A credit score is affected by various factors. For example: how often you pay your bills on time, how much money you owe, etc. The better your score, the more likely you will be able to get a loan or a credit card. Maintaining a positive track record in these areas can bolster your credit score and enhance your eligibility for favourable business loan terms.
Credit Score for Business Loans Without Collateral
Collateral refers to assets or property that a borrower commits to a lender as security for a loan. If a borrower doesn't repay the loan, the lender can take away the security to recover the funds.
While collateral can reduce the lender's risk, not all businesses have sufficient assets to offer as security.
In such cases, unsecured business loans become a viable option. Unsecured loans don't require security hence making the borrower's reliability even more important.
Lenders assess the credit score for business and financial history to determine the likelihood of timely repayment. A strong credit score can help if you are not able to present security for your loan. This makes it more likely for a business to get an unsecured loan.
Nevertheless, businesses equipped with valuable assets to put up as collateral can rely heavily on secured loans for financial support in managing business operations or fuelling working capital.
Minimum Credit Score Required for a Business Loan
The minimum credit score required for a business loan can vary based on several factors, including the lender, loan type, and borrower risk.
If an individual is considering applying for a loan, a credit score of 700 or higher is required. However, other lenders may have varied minimum credit score thresholds.
Additionally, if your business is new, lenders might consider the personal credit scores of business owners to assess the business's creditworthiness.
Why is Credit Score Important for a Business Loan?
Credit scores offer banks and NBFCs a consistent and unbiased metric for evaluating loan applicants. This standardized approach empowers lenders to make reliable and well-informed lending choices, enabling them to better handle risk assessment and allocate resources efficiently. It also expedites the identification of prospective borrowers who are more likely to meet their financial commitments, simplifying and expediting the loan approval process.
For instance, a higher credit score signifies lower risk as it reflects a track record of responsible financial behaviour and an increased likelihood of prompt loan repayment.
How Does Your Credit Score Impact Your Eligibility for a Business Loan?
Your credit score directly impacts your eligibility for a business loan and the terms you'll be offered.
The influence of your credit score extends beyond eligibility. It plays a very crucial role in determining the terms of your loan, such as the interest rate and loan amount.
Lenders prefer lending money to people who have good credit scores since such people are more likely to pay them back. Therefore, someone with a poor credit score usually does not get favourable terms for a loan.
Documents Required for Credit Score Business Loan
When a company seeks a business loan, it is required to submit a range of documents to the bank. These documents provide the bank with insights into the company's financial standing, including its current assets and liabilities, as well as the amount of funding it intends to borrow. The bank evaluates these documents as part of the business loan application process to determine whether the company qualifies for the business loan.
If your business documents like identity proof, income tax returns, and other business operating documents are in order and establish your credibility to repay the loan, the bank or financial institution grants instant approval for the business loan.
Business Financial Statements
Business financial statements depict the profitability of a business. They tell you about your company's expenses, income and profit. There are three types of business financial statements: the balance sheet, the income statement, and the cash flow statement.
The balance sheet shows how much money you have and how much you owe. The income statement shows how much money you make and how much money you spend. The cash flow statement highlights your business's ability to manage cash and what amount of it is coming in or going out. This shows the business's operational efficiency.
Personal and Business Tax Returns
Lenders often request both personal and business tax returns from the borrower.
Personal tax returns provide detailed information regarding an individual's income, deductions, and any other source of revenue.
Conversely, business tax returns offer valuable insights into a company's financial activities, displaying its income, deductions, and tax obligations.
Reviewing these returns helps lenders gauge your financial stability and ability to meet your tax responsibilities.
Business Plan
A business plan shows what you want to do with the money you wish to borrow.
A well-structured business plan accomplishes two crucial objectives. Firstly, it brings about confidence in lenders that they can safely lend money to the business. Secondly, it provides them with a clear understanding of how the loan will actively contribute to the growth and profitability of your business.
Bank Statements
You need to provide bank statements to show the financial health of the company.
Lenders examine these statements to assess your liquidity, cash reserves, and how effectively you manage short-term financial obligations.
How to Improve Your Credit Score for a Business Loan?
Follow these detailed steps to improve and enhance your credit score:
Monitor Your Credit Report:
Always check your credit report to make sure that the information is accurate. Check for incorrect information and other discrepancies.
Timely Payments:
Consistently make on-time payments for all credit obligations, including credit cards, loans, and utility bills. Late payments can strongly impact your credit score. Setting up automated payments or reminders can help ensure timely payments.
Reduce Credit Card Balances:
Aim to decrease your credit card balance by reducing the amount of credit used. This affects your credit utilisation ratio. This ratio denotes the percentage of available credit that you're currently using.
Diversify Your Credit Mix:
Maintain different types of credit accounts, such as credit cards, instalment loans, and mortgages. However, avoid opening too many new credit accounts as frequent applications can harm your credit score.
Manage Debt Responsibly:
Focus on managing your existing debt by making consistent payments and avoiding maxing out credit limits. Responsible debt management shows lenders that you can handle financial obligations effectively.
Limit New Credit Applications:
Each time you apply for new credit, a hard inquiry is generated on your credit report, which can temporarily lower the score. Limit unnecessary credit applications, especially when you're actively working on improving your credit score.
Things to Keep in Mind Before Applying for a Business Loan
Before applying for a business loan, several considerations can enhance your chances of success:
Assess Your Financial Health:
Check how much money you need to run your business and how much you make and need for daily operations. You need to review your financial health for better loan terms.
Loan Purpose:
Whether for expansion, equipment purchase, or working capital, having a well-defined plan demonstrates to lenders that you have a strategic vision for how the loan will contribute to your business's growth and success.
Lender Options:
Research and compare different lenders to find the one that offers the most favourable terms for your credit score and business needs.
Gather Required Documents:
Prepare all necessary documents in advance to streamline the loan application process. It is essential to verify the accuracy, currency, and accessibility of your financial statements, tax returns, business plan, and other pertinent documents.
Work on Your Presentation:
Give equal attention to the necessary documentation and how you present yourself and your business. A good representation increases your chances of getting a loan.
Conclusion
Organisations use credit scores to decide if they can get a loan. If you have a good credit score, you can get a loan with a low-interest rate. If you have a poor credit score, you may not get a loan. Thus, aiming for a higher score should be a priority.
By understanding the impact of credit scores, diligently managing your financial responsibilities, and preparing a strong loan application, you can pave the way for securing the funding necessary to drive your business forward.
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FAQs
How much credit score is needed for a business loan?
The required credit score varies by lender and loan type, but a higher score (above 700) improves your chances of favourable terms.
Can I get a business loan with a credit score of 600?
A credit score of 600 may lead to higher interest rates and more limited options for business loans.
Is credit score mandatory for a business loan?
In most cases, yes. While most lenders use credit scores to assess risk, some lenders might consider other factors too.
Do business loans depend on credit score?
Credit scores strongly influence loan terms, including interest rates and approval likelihood, especially for traditional lenders like banks.
How to check credit scores for business loans?
You can check your credit score through Shriram Finance website or utilize their online credit monitoring services via Shriram One app to access this information.
What is a good credit score range to get a business loan?
A credit score in the range of 700 to 800 is considered suitable for obtaining favourable business loan terms.
How to get a business loan with a low credit score?
If you have a low credit score, explore options like secured loans, finding a co-signer, or improving your score before applying.
Does credit score affect business loan eligibility?
Yes, credit score impacts loan eligibility, interest rates, and terms, reflecting your ability to manage debt.
How to avail of a business loan without a credit score?
If you need a business loan, consider building credit with a personal credit history or exploring alternative lenders.
How does a good credit score help in securing a business loan?
A strong credit score demonstrates financial responsibility, increasing lender confidence and improving loan terms.
How do credit scores affect business loans?
Higher credit scores often lead to lower interest rates and loan amounts, while lower scores result in limited options or higher interest rates.