Many small business owners turn to loans to help get their business off the ground or to finance an equipment purchase for an established company. But some small business owners must overcome a bad credit score in order to secure a loan.
The fact is, it’s tough to qualify for a business loan with bad credit. Experts suggest improving your credit score before seeking a business loan, but that takes time—time you might not have. Read on to learn how to get a business loan with bad credit.
Can You Get a Business Loan With Bad Credit?
Yes. It’s possible for small business owners with poor credit to get a business loan. Just keep in mind that lenders will see you as a risky borrower, so your loan options will likely come with higher interest rates, shorter payback periods and stricter terms.
Consider ways to reduce your appearance of risk prior to shopping for loans. Get your books in order so you can share clear financial records with potential lenders, and prepare a business plan to show them how you would use the money. If possible, offer to make a large down payment or gather a list of potential collateral.
7 Factors Lenders Consider Before Issuing a Business Loan
Lenders look at several factors when evaluating applicants for business loans. Understanding lenders’ considerations can help you get organized and demonstrate that your business is creditworthy despite the risk.
1. Credit Score
When applying for business loans, two types of credit scores matter: your business credit score and your FICO score.
Your FICO score is tied to your Social Security number and can range from 300 to 850. It rates your personal credit based on your credit history. This includes your payment history, credit utilization (how much available credit you’re currently using), length of credit history, credit mix and inquiries for new credit. Three credit bureaus report on your credit: TransUnion, Experian and Equifax. You can request a free copy of your credit report from all three agencies on AnnualCreditReport.com. If you find any mistakes, make sure to correct them. Your personal credit score can factor into your business credit score.
Your business credit score is tied to your employer identification number and can range from one to 100. It gets calculated by Equifax, Experience and Dun & Bradstreet, all of which create business credit reports using their own methodology.
2. Debt-to-Income Ratio
Your debt to income (DTI) ratio is another indicator of your financial health. Find both your personal DTI and your business DTI. Start with your cash flow report to see the full picture of your incoming and outgoing funds. Add all your monthly debt payments and divide that total by your average monthly income before taxes.
If your DTI is lower than 36%, then you will be a more attractive applicant to lenders. That said, most experts say that a DTI below 36% is ideal, but a ratio below 50% is acceptable.
If your DTI is above 50% and you have bad credit, start paying down your balances to improve your chances at securing a bad credit business loan.
3. Cash Reserves & Down Payment
Another way to improve your chances at qualifying for a business loan is by keeping enough cash on hand to cover several months of expenses. Your business’s cash reserves function the same way as an emergency fund for your personal finances.
Keeping cash reserves signals to lenders that your business could still cover loan repayments if your income slows down or if you’re hit with unexpected expenses. Your cash reserves can also help you pay a larger down payment on a loan, if necessary.
Six months’ worth of expenses in your cash reserves is ideal, but aim for at least three months if you’re just getting started.
4. Collateral
Presenting collateral is another strategy small business owners with bad credit can use to secure a business loan. Common business collateral includes real estate, vehicles, stocks, inventory and business equipment. When you use collateral to qualify for a loan, lenders may be more comfortable lending you money.
5. Annual Revenue Requirements
Many lenders’ eligibility requirements include a certain amount of annual revenue. Most tend to require businesses to have at least $100,000 in annual revenue. Lenders view these businesses as more likely to make their monthly payments.
Some lenders and some types of loans, like equipment financing, don’t require a minimum annual revenue, but it’s still an important factor to consider for small business owners with bad credit.
6. Years in Business
Typically, the longer you’ve been in business, the easier it will be to get a business loan. This is especially true once you surpass five years—the time period during which most failed businesses close their doors.
7. Business Plan
Providing a professional business plan can give potential lenders more confidence in you and your business. Explain where your business fits into its industry, how you’ll market your products or services and your sales strategy. Within the plan, introduce your leadership team. Address potential red flags by being upfront about current weaknesses and share your realistic plan for overcoming them.
What Is the Minimum Credit Score to Get a Small Business Loan?
In general, you need a FICO score of at least 530 to qualify for a business loan. Some alternative lenders offer bad credit business loans to business owners with a credit score as low as 500, provided they meet other requirements. Keep in mind that your interest rates are likely to be much higher (potentially up to 40%) than is typical for borrowers with good credit.
Types of Business Loans for Bad Credit
Small business owners with bad credit scores can pursue several different avenues for securing credit. Here are eight types of bad credit business loans and financing options.
1. Short-term loans
Short-term business loans share many similarities with conventional loans. The difference lies in the length of their terms. With short-term loans, the payback period typically lasts a maximum of three years, so lenders look more closely at your immediate ability to pay a loan back rather than your credit history. This makes short-term business loans a potential option for small business owners with bad credit but good cash flow and decent cash reserves.
2. Hard money loans
Small business owners with valuable collateral may be able to qualify for hard money loans despite their bad credit. That’s because hard money loans are backed by collateral rather than credit history. Just remember the potential drawbacks: If you can’t make your payments, your lender can take possession of your collateral. For instance, a manufacturer who uses their machinery as collateral for a hard money loan must be prepared to let their lender take possession of this collateral if they default on loan payments.
3. Invoice financing
Also known as invoice factoring, this type of financing lets business owners obtain a loan based on their outstanding invoices. Essentially, they sell their accounts receivable invoices at a discount to a lender that offers them a portion of the funds as a lump sum.
Here’s an example: Let’s say you’ve issued an invoice for $5,000 dollars. If you use invoice factoring, you could sell the value of this invoice for just $3,500 to $4,500, but you can access those funds immediately. In this case, the lender is more concerned with your customers’ ability to pay than your business’s credit. When your customer pays the invoice, your lender keeps the full amount. This type of financing is best used only for a short period of time, during high growth or seasonal slow downs.
4. Microloans
The Small Business Administration (SBA) provides microloans administered by nonprofit lenders. Typically this type of business loan goes up to $50,000 and helps small business owners gain working capital for inventory, building improvements, furniture or equipment. When choosing an SBA loan, business owners with bad credit may want to shop for microloans as they’re more likely to qualify with nonprofit lenders.
5. Business Credit Card
If you have a poor credit score, you may still qualify for a business credit card, though your annual percentage rates are likely to be higher and your credit limit will likely be lower.
If you use your card wisely and pay off the balance each month, you can eventually increase both your card’s credit limit and your business credit score. Building a credit history on a business card can also help you separate your personal and business credit histories. Depending on which business credit card you use, your business may also enjoy several additional benefits.
6. Equipment Financing
Small business owners with bad credit have a better chance of qualifying for equipment loans than typical business loans. That’s because the equipment they finance can act as collateral for the loan.
Many equipment loans come with fixed interest rates and a fixed payment schedule, so financing your equipment purchases or leases with this type of loan can also give you a more predictable and stable repayment experience.
7. Business Line of Credit
This type of financing operates like a hybrid of short-term business loans and business credit cards. In this case, a lender determines the amount of money they’re comfortable offering to your business. They keep this pool of funds open, letting you draw from it as needed. As a business owner with bad credit, you’ll pay a higher interest rate, but you only pay it on the amount you borrow, rather than the full amount of credit available.
8. Merchant Cash Advance
Considered by many to be the financing option of last resort, merchant cash advances are based on your typical sales volume and offer a quick way to access capital. A lender will assess your records then offer you a lump sum. Moving forward, you’ll pay it back with a portion of your credit card and debit card sales in addition to other fees. Like payday loans, merchant cash advances tend to be a more expensive form of borrowing money.
Pros and Cons of Bad Credit Business Loans
While bad credit business loans are necessary for some business owners, it’s best to use them only when necessary. As you pay them off, work to improve your credit score so your business can qualify for more favorable loan terms in the future.
Advantages of bad credit business loans include:
- Your business has the opportunity to access funds for immediate needs.
- You can use them to repair your credit score.
Drawbacks of bad credit business loans:
- Higher interest rates make it more expensive to borrow money.
- You’ll need to allow a deeper audit of your business finances.
- They typically offer lower loan amounts than traditional loans.
Choosing the Right Lender
Start by looking for lenders that offer your preferred types of financing. Research their eligibility requirements to understand how they determine whether applicants qualify for a loan.
Once you have a short list of options, narrow down your choices by looking at each lender’s specific offerings, including the terms and the cost of borrowing money. Then assess their customer service based on how they’ve treated you and on what you read in online reviews.
Learn more about how to apply for a business loan.
Frequently Asked Questions About Getting a Business Loan with Bad Credit
How do you get a business loan with bad credit?
You can qualify for certain types of business loans despite having a bad credit score. You may need to accept loans with shorter terms and higher interest rates. You can also look for ways to reduce your risk factors by offering collateral, making a large down payment, and sharing a strong business plan backed by organized financial records.
Can you get a business loan with bad credit?
Yes. It’s possible to obtain a business loan or other types of financing, even with poor credit. Keep in mind that you’re likely to pay higher interest rates and face shorter payback periods. Most alternative lenders that offer loans to business owners with bad credit look for a FICO score of at least 530, though some lenders will work with borrowers with scores as low as 500.
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