How to get a business loan with a bad credit score

What is a credit score?

A credit score (also called a credit rating) is just one of the tools banks use to determine an individual’s creditworthiness. It’s a three-digit number between 300 and 900 that represents your past credit behaviour (such as your ability to pay your bills on time).

The higher your score, the better your chances of getting approved for new credit from the banks.

What is a bad credit score?

A poor credit score falls in the range of 300 (the lowest possible credit rating number) and 559.

A fair credit score falls in the range of 560 to 659. A good credit score is 660 to 724, while a very good score is between 725 and 759.

An excellent credit score would be between 760 and 900 (the highest possible credit rating number).

How are credit scores calculated?

Credit scores are determined by credit reporting agencies such as Equifax and TransUnion. The factors that impact an individual’s credit score include:

• credit history: length of time credit has been established
• payment history: number of late payments, bankruptcy filings and debt collections
• utilization: percentage of available credit remaining
• frequency: number of requested credit checks

When you apply for a personal or business loan, banks will rely on the reports provided by the credit reporting agencies—which include your credit score—to help determine whether they should lend money to you or not.

“Many people are not aware that their consumption habits can affect their credit score. And they don’t realize that this can hamper their business as well,” says Valérie Bornais, Manager, Sales Enablement with BDC. “In fact, they should know that financing is often granted based on personal credit history.”

However, while your credit score is an important tool for assessing your creditworthiness, it is not the only thing banks will look at when reviewing your loan application.

How do banks evaluate a business loan application?

Financial institutions review business loan applications based on the five Cs of credit.

• Character: This is the credibility you have with lenders (in other words, your credit score) but also the educational background, specialization, expertise and entrepreneurial experience you bring to the table.
• Capital: The amount of money you can invest in the project. The more of your own money you can contribute to the project as a percentage of the total investment, the lower the risk for the lender.
• Capacity: Your income, expenses and debt, generally expressed as a debt-to-income (DTI) ratio. The DTI is a comparison of income against recurring debts. A higher DTI ratio indicates higher debt levels relative to your income, increasing the risk for the lender.
• Collateral: This is an asset or property the bank can seize should you default on payments. (Think of it as another source of repayment.) The greater the value of the collateral provided, the lower the risk for the financial institution.
• Conditions: These are the circumstances of the loan itself, such as the amount, interest rate and amortization period. The state of the economy in your line of business can also impact the conditions of the loan.

The good news is that your credit score is just one of five criteria used by banks to assess your creditworthiness. So, if you’re very strong in everything but the character criteria, there is still a chance you can overcome your bad credit score, says Jamohl Rutherford, Manager, Entrepreneurship Centre, at BDC.

“We won’t refuse you just because of a poor credit score,” he says. “By highlighting the strengths of your business in the other four Cs, you can improve your chances of the banker making a favourable decision about your loan.”

How do I get a business loan with a bad credit score?

The following tips can help you improve your chances of having your application approved.

Tip 1: Present a strong case across all five Cs of credit

Banks will more likely approve your loan application when you can lower the risk your poor credit score poses to them. You can strengthen your application by doing the following:

• Highlighting other character attributes beyond your credit score
  Providing an in-demand service or holding a highly specialized degree will improve your chances of getting a loan approved.
• Being able and willing to invest in your business
  The more capital you can contribute upfront, the more likely the banks will contribute to your project.
• Having a clear and detailed plan in place to repay both the principal and interest of your loan
  Coming prepared with supporting documents, such as contracts and purchase orders that demonstrate your ability to pay the money back, will increase your credibility with lenders.

Compared to established businesses, start-ups with bad credit scores have the added challenge of not being able to provide any historical data about their capacity to service a loan. For them, it is crucial that they provide strong forecasts and showcase their ability to repay the loan.

“When you have a bad credit score, you need to be very strategic and paint a really favourable picture for the remaining criteria,” says Rutherford. “It’s challenging, but not impossible.”

Tip 2: Be transparent

Always be honest and upfront about what led to your bad credit score. Lying or trying to hide facts won’t help your case. Provide context by describing the circumstances that led to your situation. This may help the bank look more favourably at your application, especially if you had a good credit score in the past.

“A bad credit score may be the result of an unfortunate event beyond your control, such as a divorce,” says Bornais. “If your business idea is sound, the bank will be more willing to take a risk and help you out.”

Rutherford agrees that there are often good reasons for a credit score being low. “We always look at what’s behind the number,” he says.

Tip 3: Find partners

Consider teaming up with one or more associates who possess impeccable credit histories. Having a more qualified and financially sound management team may help tip the scale in your favour.

If you do form a team, it’s important to have a lawyer draft an agreement that determines everyone’s roles and responsibilities.

If you find a friend or family member to act as a guarantor on a loan, the person must meet the lender’s eligibility criteria. The lender’s decision will be based on a review of the guarantor’s credit history and net worth.

The friend or relative must also be aware of the commitment they are making. Being a cosignatory on your loan will appear in their credit history and may limit their borrowing power. They must also be clear on the extent of their liability should you be unable to meet your obligations.

What are the other implications of a poor credit score?

Although a bad credit score doesn’t automatically preclude you from getting a loan, it can have other consequences on your business and financial situation. If you have a low credit score, expect higher interest rates than those with excellent credit scores. Application processing times will also take longer if you have a low credit score due to the increased level of due diligence required by the banks.

But poor credit is not forever, says Rutherford. Being aware of what may have contributed or still is contributing to your bad credit score is crucial—and often the first step toward putting plans in place to improve your credit score. From there, you can greatly improve your chances of success with your next business loan.

“Use your opportunities to improve your credit score and look at the process from the institution’s perspective,” he says. “Financial institutions want to help entrepreneurs and provide the financing they need, but they also need to make sound financial decisions.”

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