Bad Credit Business Loans: The Trade-Off

There is a trade off. Business owners with bad personal credit can often secure financing, but the more perceived risk the lender assumes because of your poor credit history, the more likely you are to pay a higher annual percentage rate (APR) to mitigate the extra risk.

This can seem counterintuitive—why would lenders charge more to the business owners who historically have the most trouble paying back debts? Doesn’t it make sense for the lender to charge less so the bad credit borrowers will have a better chance of paying it back?

That may sound better from the borrower’s perspective, but unfortunately it’s the lender’s money, and thus the lender’s ball game. Lenders look at your credit history and try to determine what you will do in the future based upon what you’ve done in the past (your credit profile). Lenders charge a higher interest rate to individuals with low credit scores to offset a higher expected default rate. Lenders need you to make each and every periodic payment in order to return a profit. They lose money if you default and the higher interest rates they charge less creditworthy borrowers helps mitigate some of that risk.

Let’s take a look at some of the better options when it comes to business loans for bad credit.

How to choose the right business loan with bad credit

A less-than-perfect credit profile makes it more difficult to qualify for a loan so you should expect it to take more work to find a lender willing to work with your business. If your credit profile is struggling, the steps I recommend for financing include:

1. Find out what your credit profile looks like right now. That includes your personal credit score and your business credit profile. All the major credit bureaus offer businesses the opportunity to see what they are reporting. You can also see both your personal and business profiles for free at EcoCredit.
2. Depending upon your credit profile, limit your search to lenders that are likely to offer you a loan. For example, most banks will want to see a personal credit score above 680 (preferably in the 700s), the SBA will sometimes approve a borrower with a score as low as 640, and some online lenders will offer a term loan or business line of credit to a borrower with a personal credit score of around 600. Merchant Cash Advances are available to small business owners with a personal credit score as low as 500, but realize that there is a relationship between ease of access and cost. For example, a Merchant Cash Advance will be much more expensive than a term loan or line of credit from the bank or an SBA loan. Spend your time where the odds of success will be the greatest. And don’t be surprised if the options are more expensive if you have a bad credit history.
3. Don’t avoid non-profit microlenders because the loan amounts are typically small. These can be very low or even no-interest loans that can provide a lot of value. If your business can leverage a small amount of money and turn it into a big impact, these lenders could be a great choice.
4. Make sure you have the cash flow to support the larger periodic payments often associated with the non-traditional lenders that will work with a business with less-than-perfect credit. You also need to be aware that many of these lenders will expect daily or weekly direct debits from your business banking account, so you’ll want to ensure that you not only have the cash flow to service the debt, but that you have the consistent cash flow going through your business to support a potential daily payment schedule.

Less-than-perfect credit can be a symptom of underlying financial stress on a business. Before you take a loan, make sure your financial house is otherwise in order. Most lenders understand that there are sometimes circumstances (like the aftermath of the current COVID-19 crisis) that will pull a business credit profile down, but that makes it more important than ever that you understand your profit and cash flow situation.

Unfortunately, the higher-interest loans available to borrowers with weak credit can wreak the most havoc on those same borrowers if they aren’t very careful with the lender they choose, the amount they borrower, and how they manage their cash flow to make the periodic payments.

You can learn more about additional small business financing options here.

What is Considered Bad Credit?

What is considered bad credit for one lender might be considered OK credit for another. With that in mind, it might be easier to describe what good credit it and work back from there.

800-850 (Exceptional): With a score above 800 borrowers will be able to choose the credit options that are optimal for their situations, often with the lender they choose.

740-799 (Very Good): If your credit score falls within this range you are considered a low-risk borrower. A borrower with this credit score will be able to pick and choose the loan that makes the most sense for their business use case.

670-739 (Good): This is considered a good score and many in the U.S. fall within this range. A borrower with this type of score can expect to see more options and more approvals.

580-669 (Fair): This is considered a moderate-risk score. A small business loan is very possible, but will likely not come with the best interest rates. Most traditional lenders won’t offer a small business loan to borrowers in this category.

500-579 (Poor): There is some financing available for borrowers with this type of credit score, but it’s considered a high-risk score and will likely come with fewer options and higher interest rates. 

Below 500 (Very Poor): With this credit score it is unlikely a business owner will qualify for a business loan.

What to do if you can’t get approved for a business loan

Although there are options available to borrowers with a poor credit score, not every loan application will be approved. For those borrowers who can’t get a business because of their poor personal credit score, taking actions to start improving your score today is where they should focus their attention.

There is no short-cut to a strong personal score, but there is good news. Over time, consistently working on your personal score will help you improve your score. Taking these steps will put your score on the path to recovery:

1. Monitor your credit: It’s human nature to impact the things we pay the most attention to—and that includes your personal credit scores. Fortunately, it’s possible to monitor your score with EcoCredit or a handful of other platforms for free. Alternatively you can pay for services available from the major credit bureaus to monitor your credit. This is also important to ensure the information in your credit report is accurate. All the credit bureaus have a process in place to correct inaccurate or mistaken information.
2. Reduce your monthly credit obligation: A big part of how your score is calculated is the ratio between the amount of credit you have available and the amount of credit you use. Keeping your credit usage below 20-30% should be the goal. If you have three credit cards and currently pay only the minimum amount due on all three, pick one, start paying more than the minimum until you have that card paid off. Then start on the next card. The more below 20-30% you can go, the better.
3. Make each and every loan or credit card payment on time: The single most impactful thing you can do to improve your score is to make your periodic payments on time. It won’t change your score overnight, but creating a track record of timely payments will improve your score.

By following these three guidelines, you might be surprised at how quickly you start to see results. Don’t trust anyone who wants to charge you upfront to fix your score. The bureaus have seen all the gimmicks and schemes and will see right through them if you try them. It might even further hurt your score. This is one case where slow and steady really does win the race.

Bottom Line

Don’t give up on finding financing for your business if your credit is less than perfect. Look into alternative lending options and work on your credit in the meantime. You may need to start small, but use each amount of financing you get as a stepping stone to grow your business.