Last Updated on August 26, 2021
Financing a business isn’t always straightforward. There are periods you have to take loans to sustain your business. The business ecosystem is very volatile, meaning your company can sometimes default on loans. And that’s when your business finances can get mingled up with personal credit. But do business loans affect personal credit?
The answer to this question is yes. A business loan may affect personal credit scores. Of course, it depends on the type of business loan and how you acquire credit.
Situations When Business Loans Affect Personal Credit
There are several types of business loans, and each has a different effect on personal credit. Most business loans affect your credit if you personally guarantee a business account.
When starting small businesses, most owners personally guarantee loans. This scenario is common among sole proprietors and partners. If the business defaults on its loans, the lender has the right to collect payments from you. As a cosigner, the lender will report defaulted business loans on personal credit reports.
Another instance where business loans might affect your credit scores is when you use personal credit to fund your enterprise. So, if you use personal loans like home equity loans to finance your company, the payments will reflect on your credit reports.
The same applies to a business line of credit. It might impact personal credit if you guarantee the line of credit. The impact on your credit scores can either be positive or negative. If your business struggles to repay debt, the effect will be negative.
Situations When Business Loans Do Not Affect Personal Credit
A business loan won’t impact your credit if you keep your business and personal finances apart.
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.
Another way business loans don’t impact personal credit is when your company has a business credit card. If you’re an authorized business user for the card, it won’t appear on your credit reports.
When picking a business credit card, go for cards that don’t frequently report financial activities to consumer credit reporting agencies. To prevent credit card issuers from reporting your business to credit bureaus, you must be punctual with your payments.
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.
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.
Business loans won’t affect your credit if you only provide an EIN 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.
How A Business Loan Could Affect Personal Credit
Businesses incur debts in the form of loans, business credit cards, overdrafts, and credit lines. If you run a sole proprietorship or partnership, there are high chances you’ll be responsible for loan repayments.
Three factors determine whether a business loan can affect personal credit. These factors are:
- The structure of your business
- The type of business loan
- How you handle the loan default
Different forms of businesses will have varying impacts on your credit scores.
If you’re a sole trader, your credit score is also your business’s credit score. 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.
The same applies to a partnership business. 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. Any loan taken by a partnership business will affect the personal scores of all the partners.
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.
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.
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.
How You Resolve the Default
Although huge loans can be beneficial to your company, they expose the company to significant risks. If your business defaults on such loans, it 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.
How a Business Loan Affects Your 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:
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.
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
How to Build Business Credit
The earlier your business builds a credit history, the better the chances of securing finances.
The first step is to register your company with major credit reporting bureaus. Afterward, open a business bank account and keep it active. You need to make business transactions through this account frequently. You can transact with vendors, manufacturers, and suppliers.
Once you build a working relationship with vendors, you can request them to submit payment reports to business credit card reporting agencies. You’ll get positive ratings if you constantly make payments promptly.
Ensure you monitor your business credit file. You may encounter inaccurate information or errors. You can always submit corrections or dispute erroneous payments.
The next step is to seek business financing. You can either go for a loan or a business line of credit. Always use the business’s name when taking business loans.
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.
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.
Grey is the Director of Marketing for altLINE by The Southern Bank. With 10 years’ experience in digital marketing, content creation and small business operations, he helps businesses find the information they need to make informed decisions about invoice factoring and A/R financing.