Does a Business Loan Affect Personal Credit?
Last Updated October 10, 2024
Financing a business isn’t always straightforward. There are periods you have to take loans to sustain, or even kickstart your business. Since the business ecosystem is very volatile, your company must sometimes default on loans, and that’s when you might think your business finances can potentially get intertwined with personal credit. But do business loans actually affect personal credit?
The answer to this question is yes, a business loan can affect personal credit scores. However, it depends on a few factors such as the type of loan you’re applying for, how you’re obtaining the credit, and your business structure.
Continue reading to get clarity on whether or not your personal credit will be affected by your particular business loan.
What Determines If a Business Loan Affects Personal Credit?
Businesses incur debts in the form of loans, business credit cards, overdrafts, and credit lines, and if a personal guarantee has been signed by the borrower, it can affect personal credit. If you run a sole proprietorship or partnership, there is a good chance you’ll be responsible for loan repayments.
There are three main factors that will determine whether a business loan will affect your personal credit. These factors are:
- The structure of your business
- The business loan you’re utilizing
- How you handle the loan default
1. Your Business Structure
Different forms of businesses will have varying impacts on your credit scores.
- Proprietorship Business: If you’re a sole trader, your credit score is also your business’s credit score, so even if you don’t sign a personal guarantee, it’s still a reflection of your personal credit because you and your business are the same entity. As the owner, you’re liable for any loan the business takes. If your enterprise defaults, it will affect your credit ratings.
- Partnership Business: Any loan taken by a partnership business will affect the personal scores of all the partners. The lender will always demand the credit details of all the partners involved in the partnership. If a partnership business cannot repay its loans, partners are responsible for clearing its debt. If the partnership is an LLP, partners will only pay some percentage of the overall debt.
- Limited Company (Corporations): Unlike sole proprietorships and partnerships, limited companies operate as separate legal entities. Shareholders have limited liability, meaning they aren’t liable for the company’s debts. Therefore, the company’s ability to repay loans cannot affect your credit reports. However, lenders might request personal credit details from directors and owners before granting loans.
2. Whether a Personal Guarantee is Tied to the Business Loan
Lenders often require security or personal guarantee before approving business loans. You can use the business’s assets to secure loans, and this move won’t affect personal credit. But if you personally guaranteed the loan, you’re responsible for repaying it if the business defaults.
Personal guarantees are standard for start-ups and small businesses that lack sufficient credit history. Most lenders will also require a personal guarantee if your business is applying for an unsecured loan. Any late payments or defaults your business accrues will have a significant impact on your credit.
3. How You Handle the Loan Default
Although huge loans can be beneficial to your company, they expose the company to significant risks. If your business defaults on such loans, you might face bankruptcy.
When creditors are unable to deal with your insolvent company, they might turn to your assets. This forces many business owners also to declare personal bankruptcy.
When a bankruptcy appears on your reports, it will severely damage your credit scores. You may struggle to qualify for personal loans, auto loans, or mortgages.
Situations When Business Loans Do Not Affect Personal Credit
As long as you completely separate personal finances from business finances and one of the below factors is applicable to your situation, you don’t have to worry about your business loan affecting your personal credit score.
1. Purchasing a Business Credit Card (If No Personal Guarantee Is Signed)
When picking a business credit card, go for cards that don’t frequently report financial activities to consumer credit reporting agencies. That way, if you’re an authorized business user for the card, payment history won’t appear on your personal reports. As mentioned above, certain credit issuers will report payment updates to consumer agencies more than others.
With that said, if you’re a sole proprietor, lenders consider you more than an authorized card user. If you personally guarantee the account, the business credit card will appear on your reports.
2. Obtaining a Business Loan for an Incorporated Company
Business loans from incorporated companies rarely affect personal credit. Unlike sole traders and partnerships, incorporated entities like LLCs, C corporations, and S corporations have their own corporate identity. As a shareholder, you won’t be liable for any debt the company incurs or fails to pay.
3. Opting for Loans Against Your Retirement Plan
Instead of financing your business using personal credit cards, you could opt for loans against your retirement plans like 401(k). These loans won’t show up on your credit reports.
4. When Providing an EIN During the Loan Application
Business loans won’t affect your credit if you only provide an EIN (Employer Identification Number) during the loan application. Lenders cannot hold you liable if you sign on anything that doesn’t request your official name and social security number.
A Business Loan Can Affect Personal Credit If a Personal Guarantee Is Signed
If your lender requires you to sign a personal guarantee, that means the business loan can impact your personal credit score, regardless of the type of financing.
What is a personal guarantee? Simply put, a personal guarantee on a loan means lenders require borrowers to promise (or “guarantee”) that credit issued will be repaid by a certain point, taking personal responsibility if their business defaults and can’t pay back the financial institution. These are written into the contract during the onboarding process.
As a business owner, you shouldn’t be put off if a lender requires a personal guarantee to be in place. It’s customary for business loans and lines of credit to be secured this way, especially if funding isn’t backed by collateral. Lenders have small business owners sign a personal guarantee as an alternative to collateral, thus reducing risk for credit issuers.
This is why personal guarantees are especially relevant for small business owners, who often lack the significant collateral needed to qualify for traditional bank loans. It’s also common for lenders to require small business owners to personally guarantee loans if they have a lack of business credit history entirely.
Loans with a personal guarantee are the most common instance of business loans having an impact on personal credit. If a personal guarantee is in place, your behavior and payment habits regarding your business loan will have an affect your personal credit. The good news is that if you’re reliable with paying off the loan, that can have a positive reflection on your personal credit score.
It’s most common for lenders to require small business owners personally guarantee loans due to a lack of business credit history, especially for sole proprietors and partners. If the business defaults on its loans, the lender has the right to collect payments. As a cosigner, the lender would then report defaulted business loans on personal credit reports.
Do Business Credit Cards Affect Personal Credit?
Even if you don’t sign a personal guarantee, many credit issuers will base approval for credit cards off of personal credit, so applying for a business credit card can sometimes lead to a small hit to your personal credit score because of the hard inquiry from the lender. However, this is temporary, and your score will bounce back. This is most often the case with borrowers who obtain a complete lack of business credit history.
The only other instance where a business credit card can harm personal credit are from the select issuers who report serious late payments and delinquencies to consumer credit bureaus. However, as long as you’re fairly reliable to pay on-time, this shouldn’t affect your personal credit score
In-Summary: Do Business Loans Affect Personal Credit?
A business loan can affect personal credit. If you personally guarantee a business loan, your credit will be affected. If you’re a sole trader or run a partnership, your finances will also be affected by a business loan. In such instances, your credit scores will reduce if your business delays payments or defaults.
Business debts don’t impact personal credit if the company and the owner are separate legal entities. Loans against your retirement plans like 401 (k) also won’t appear on personal credit reports.
If you’re a small business owner searching for alternative financing, invoice factoring can also be a good option. Factoring isn’t a loan, rather, it involves selling outstanding invoices to a factoring company in exchange for cash advances. If you’re curious how factoring affects your credit, read the following articles:
Can a Business Loan Affect Personal Credit? FAQs
Can personal debts affect business loans?
Personal debts can minimize your chances of getting business loans. Lenders check business credit scores, but they will review personal credit if they can’t find valuable information from the business credit. This happens mostly when your company is new and lacks a healthy turnover to trade.
If you’re a sole trader, the lender must check personal credit scores before granting your business a loan. If your creditworthiness is low, the lending company might deny your business a loan.
If you use a personal credit card to fund your business, your credit history must be healthy.
How can a business loan affect my company’s business credit?
A business loan can impact your company’s credit score in both positive and negative ways.
Most small businesses use business credit cards to boost their working capital. However, companies that have credit cards must be cautious about their credit score and credit history.
Whenever your business takes a loan, the lending company will forward the payment history to business credit reporting agencies like:
- Equifax
- TransUnion
- Experian
These bureaus are responsible for calculating your business’s creditworthiness.
Credit card issuers report different information to credit bureaus. Some report your company’s card activities, while others report information when you default.
If your company fails to repay business loans on time, it’s likely to have poor credit scores. The same happens if your business entirely defaults on a loan.
A poor score means your business will encounter difficulties when securing future finances. It will also lower your company’s credit capacity. Everyone in business views a lack of creditworthiness as a sign of fiscal irresponsibility. Creditors and other companies won’t trust your business.
In contrast, your business will have excellent credit scores if it makes timely payments to lenders and creditors. Positive credit scores show fiscal responsibility, and lenders can easily trust your company. Your business can quickly secure finances if it has positive credit ratings.
What other factors can affect business credit?
Business loans aren’t the only factor that affects business credit. Other factors include:
- Company structure
- Public filings
- Historical data
- Business registration details
- Business operational details
Grey was previously the Director of Marketing for altLINE by The Southern Bank. With 10 years’ experience in digital marketing, content creation and small business operations, he helped businesses find the information they needed to make informed decisions about invoice factoring and A/R financing.
