While it has been a harsh truth, the fact still remains the same, that before approving a business loan, banks and even the private lending institutions often want to know about your personal credit profile when your business is small or still a startup. Sometimes, lenders specifically want to know the track record of the business owner, thereby giving equal weightage to personal and business credit score. It is, therefore, crucial to understand which forms of business can impact your personal score.
Well, before we discuss this further, we need to have a clear idea about the concept of Credit score for both personal and Business. A personal credit score reflects a track record of an individual’s payments of loan taken from banks and other financial institutions. The credit score is generated by credit rating agencies like Cibil score and typically ranges between 300 and 900.
You should have a minimum score of 750 to be considered for a business loan. For agencies like Cibil, the score range is vastly different for both business and personal credit score and they have different ways of evaluating the scores for both. Though normally it so appears that personal credit score is different from your business credit score, it is not true especially for a small business where you are the sole proprietor.
The founder of a small business owner is often recognized as the face of the business and their personal credit scores are closely scrutinized for MSME loans. In absence of any relationship with the bank, it becomes all the more important for lenders to check on your credit scores as a good personal credit score will offer some assurance to the lender besides reflecting upon your financial responsibility as a borrower.
Most banks, NBFCs and financial institutions consider the credit score as one of the most important eligibility criteria while reviewing the borrower’s business loan application for providing MSME and other loans. We usually try to get a business loan based on our personal credit score but a bad business loan credit score can have an effect on your personal credit score as well.
If your business credit goes into default, and you’ve personally guaranteed the account, your personal credit will be negatively affected. Additionally, if a secured business credit account is unpaid, the lender may collect the loan’s collateral if any.
Let us discuss three business structures and the extent of the impact of the business loan on the personal credit score:
- Proprietorship Business: There is hardly any distinction between the owner and the business, the credit score for business is the personal credit score. In fact, the law states sole proprietors to be liable for any form of debt in the business, hence any default will affect your personal credit score.
- Partnership Business: Personal credit score is important for Partnership business too as it is the same as a sole proprietorship. For businesses like an LLP, partners are liable for only a certain extent of the debt. Lending companies always enquire about the credit details of all the partners involved in the business.
- Limited Company: A limited company has its own corporate identity and this excludes the shareholders except for the directors and business owners from taking any liability of the company.
Now that we are already aware that our personal credit profile is linked to that of our business and it is absolutely important to maintain a good credit score whether be it personal or business, let us arrive at ways to maintain a good credit score.
- Take a loan keeping in mind that the debt should not exceed the amount of your total income.
- Avoid taking too many loans as too many loan applications or rejected loan applications can work against your credit score
- Choose shorter tenure for repayment.
So above mentioned are a couple of reasons how a business loan can affect your personal credit score. It’s inevitable for the business owners to ensure that they first analyze their business requirements, and then and only then decide on the minimum fund requirement that is required for the business, to be borrowed, so as to avoid damaging their personal credit profile.