When the time comes to seek financing for a new business, entrepreneurs may realize that their personal credit history plays a more important role than they would have expected.
To understand the impact of your credit history you need to know what criteria financial institutions use to decide whether or not to lend to your business.
How are financing applications assessed?
When studying an application, the financial institution will focus on two things: assessing the application as objectively as possible, and verifying that the borrower will be able to reimburse the loan on time.
Financial institutions rely on sophisticated statistical models to achieve these objectives. The models are based on a considerable amount of data on borrower behaviour that is accessible to financial institutions.
By applying statistical models to an individual's borrowing and repayment habits, a bank can objectively predict whether or not the applicant will be a good borrower.
The impact of your personal credit record
If you apply for credit for your small business, when first starting out or later, the lender will often ask you to guarantee the loan. A guarantee is a contract whereby a guarantor agrees to personally reimburse a loan advanced by a financial institution if the borrower defaults on the debt.
Financial institutions can refuse to lend money to your business if your own credit record is not spotless, or they can impose additional terms and conditions (such as a higher downpayment or additional collateral.)
If your credit application is accepted despite a poor credit record, you will probably have to pay a higher interest rate.
On the other hand, a spotless credit history will give you better borrowing conditions, and even a lower interest rate.
However, it is important to note that an entrepreneur's credit record is not the only criterion lenders consider. A financial institution could refuse to lend you money or add other conditions on your application, even if your credit record is impeccable.
How to maintain a good credit history
Here are five tips to keep in mind if you are planning to apply for financing:
Limit the number of financing or credit applications you make. Applying frequently may suggest that you are having financial problems or that you are having difficulty repaying your debts, and it may be time to consolidate them.
Do you have a personal line of credit? Be sure to use it wisely. A line of credit is intended to serve as a temporary source of funds when you need it. A balance that never changes is a red flag to a credit agency. If you are in this situation, consider converting this debt into a term loan.
Avoid using your personal line of credit and your personal credit cards to finance your start-up company. This is a bad way to use credit, and it makes your business accounting more complicated.
Needless to say, avoid overdrafts and NSF cheques
Even if you manage your credit responsibly, your credit file may contain errors. You can consult your file at the credit agencies, such as Equifax. If you notice errors, have them corrected as quickly as possible.
What else should you know?
Every financing application is different. That's why we recommend you talk to an SME expert at National Bank. Click here to schedule a meeting with one of our advisors, who will answer your questions and advise you on the best way to finance your future business.
The information in this article is not exhaustive and is for information purposes only. For financial advice—whether for yourself or your company—please consult your National Bank advisor or a professional (e.g., an accountant, tax specialist or lawyer).
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