Friday, December 9, 2011

Three Ways to Damage Your Credit With Business Financing

by John Ulzheimer
Unless you’re extremely fortunate there's a good chance at some point you'll want or need to get commercial financing to fund operations and growth.  One thing to keep in mind is that a bad debt will not only slow your company’s growth and profitability, but it can create cash-flow challenges and have a trickle-down effect on your ability to cover your quarterly IRS liabilities.  Conversely, a properly obtained business loan used for revenue generating activities can not only help you propel your company where you need it to go but can also be cash-flow friendly, offer tax benefits, and possibly be kept off your personal credit profiles.
Personal Credit Cards For Business Use
While it’s tempting, it’s probably not the best idea to use personal credit cards to fund your business.  But if you’re already doing so, you’re not alone.  According to the Meredith Whitney Advisory Group, 82% of small business owners use credit cards as part of their funding strategy.  If you believe the stats, and there’s really no reason not to, you’re either already doing it or will eventually.
Hopefully you’ll eventually make the move and utilize business credit cards (instead of personal credit cards) and when you do you’ll want to work on the much more difficult task of understanding whether the business credit cards you're utilizing will be reported to your personal credit reports.  Why?  30% of your personal FICO credit score is determined by your indebtedness and much of that 30% is made up of what’s referred to as  "revolving utilization", which is the relationship between the balances on your credit cards to your credit limits expressed as a percentage.
This means with each swipe of your credit cards your FICO score is heading on a vacation south of where it's at today, which means more expensive (or limited) financing down the road. For example, an aggressively marketing business credit card issuer is Capital One, which is a perfectly reputable lender.  But, “they report business card use to personal credit files”, according to Tom Gazaway, President of Hawkeye Management, a small business consultancy firm.  “You need to be aware of their credit reporting policies because it will have an impact on your personal credit scores.”
Aggressively Seeking Credit
The second thing that can lead to damaging your personal credit is the shotgun approach to applying for business credit.  “I call this the Lending Tree phenomenon”, says Gazaway.  Applying for several loans or lines of credit from multiple lenders, while seemingly prudent is rarely a wise decision if there's no method to the madness.  Multiple applications mean multiple credit inquiries and inquiries make up 10% of the points in your FICO scores.
Perhaps more importantly excessive inquiries will send a message to the rest of the lending world that you're looking all over for a loan.  When you submit that 4th or 5th application - assuming there's no strategy behind that plan - how do you think the underwriter will feel when he knows your file has been to multiple other lenders before him/her.  How would you feel to be #5 on someone’s list?
When you think about it like you almost realize that the multiple inquiries will not only impact your credit scores but they will also impact you at the “underwriting policy” level.  “The number one reason for people with excellent credit to be denied a business credit card is for having too many recent inquiries”, according to Gazaway.  Get your plan together and shop around verbally or online as much as possible before pulling the trigger on an official application.
Treating Business Credit Like a Personal Friend
First off, thinking of any lender or credit vehicle in a personal sense or as a friend is dangerous.  It’s dangerous because your lenders will drop you faster than you can flip off a light switch the minute they feel you’ve become too risky with which to do business.  The real take away, however, is to avoid treating a business line of credit the same way you would treat a loan or a mortgage.
While this might seem like “lending 101”, it’s not actually that simple.  As a nation we've become pretty knowledgeable about the basics of how mortgages and auto loans work. These are almost always fixed-rate installment loans.  This means you have the same payment every month for X number of years.  And, as most of you homeowners know, your mortgage payment is due on the first of the month but not past due until the 17th of the month.
Zoom back to the 82% of the small business owners who are using personal credit cards as a key funding mechanism in their business. Can you consistently pay your credit card(s) 17 days late without a penalty?  No way.  In fact, you can’t your credit card(s) 1 day late without penalty?  The takeaway – the due date on your business credit cards (or personal cards used for business) is not a friendly suggestion. 
© enloop, Inc.

1 comment:

  1. Business Financing is one of the most important part of your business and thanks your great article.

    Richard Jehoshua
    Business Plan Guru

    ReplyDelete