Securing business loans with bad credit can be a daunting task for many entrepreneurs, but it’s not an impossible feat. For those with lower credit scores, various financing options like short-term loans, business lines of credit, and SBA microloans can improve chances of approval. With the right strategies and perseverance, even businesses with bad credit can unlock the funds needed for growth and success.
This comprehensive guide will explore effective methods for securing a business loan with bad credit, such as updating your business plan, choosing the appropriate loan type and lender, finding a co-signer, and demonstrating strong finances. It will also delve into loan options tailored for borrowers with poor credit scores, interest rates to expect, and tips for rebuilding your business credit.
Understanding Bad Credit and Its Impact on Business Loans
What is Bad Credit?
Bad credit, in the context of business loans, typically refers to a low credit score. For personal credit, a bad credit score is often categorized as a FICO score between 300 and 579. For business credit, a bad credit score can vary depending on the scoring model used by the lender, but generally falls within the range of 1 to 49 for agencies like Experian and Dun & Bradstreet.
Impact on Business Loan Approval
Having bad credit can significantly impact a business’s chances of getting approved for a loan. According to the Federal Reserve’s 2024 Report on Employer Firms, 76% of low-credit-risk businesses were at least partially approved at major banks, while only 46% of businesses with medium to high credit risk were at least partially approved.
Lenders often use a business owner’s personal credit score to determine creditworthiness, especially if the business is new. As the business grows and establishes its own payment history, lenders may rely more on the business’s credit score.
Higher Interest Rates and Stricter Terms
Even if approved for a business loan with bad credit, the terms and conditions are likely to be less favorable. Bad credit business loans typically come with higher interest rates and fees, as the lender is taking on more risk by lending to a borrower with a poor credit history.
Lenders may also require additional assurances, such as collateral, to mitigate the risk of default. The amount and type of collateral required can vary based on factors like credit score, loan amount, and ability to repay the debt.
Rebuilding Credit for Better Loan Options
Maintaining a healthy credit score is crucial for businesses seeking better loan options and terms. Experts recommend avoiding utilizing more than 20-30% of available credit, keeping accounts open, and working to build business credit over time. By improving credit scores, businesses can increase their chances of securing more favorable business loans in the future.
Strategies for Securing a Business Loan with Bad Credit
Improve Your Credit Score
Before applying for a business loan, entrepreneurs should review their credit reports for any errors and work on improving their credit scores. A low credit score can significantly reduce the chances of loan approval or result in unfavorable terms, such as higher interest rates.
Some strategies to improve credit scores include:
- Pay down outstanding balances to keep credit utilization below 30% of the total credit limit.
- Request credit limit increases from credit card companies to improve the credit utilization ratio.
- Set up automatic payments to avoid missing due dates, which can negatively impact credit scores.
- Reach out to creditors and establish payment plans for any outstanding debts before they go into collections.
- Be transparent about negative marks on credit reports and provide explanations to potential lenders.
- Avoid multiple hard credit inquiries within a short period, as they can temporarily lower credit scores.
Choose the Right Loan Type
Business owners with poor credit should carefully evaluate different loan options and choose the one that best suits their needs and financial situation. Some loan types that may be more accessible for borrowers with bad credit include:
- Online Lenders: Online lenders tend to have more flexible credit requirements, with some accepting credit scores as low as 500. However, loan amounts may be lower than those offered by traditional banks.
- Secured Loans: Providing collateral, such as personal or business assets, can increase the chances of loan approval and potentially lead to better terms. Lenders feel more confident when they have a guarantee of recovering their money in case of default.
- SBA Microloans: Small Business Administration (SBA) microloans, ranging from $500 to $50,000, often have more flexible credit requirements, making them suitable for businesses with limited credit histories or poor credit scores.
- Equipment Financing: Equipment loans use the purchased equipment as collateral, which can make lenders more willing to work with borrowers with poor credit.
Seek Alternative Lenders
Alternative lending platforms, such as online lenders, peer-to-peer lending, and crowdfunding, can provide financing options for businesses with bad credit that may not qualify for traditional bank loans.
Some advantages of alternative lenders include:
- Flexible eligibility requirements
- Streamlined application processes
- Faster funding times
- No restrictions on how funds can be used
However, it’s important to note that alternative lenders may charge higher interest rates and fees, and the loans may not help build business credit.
Provide Collateral or Co-signers
Offering collateral or finding a co-signer can increase the chances of loan approval and potentially lead to better terms for borrowers with bad credit.
- Collateral: Valuable assets, such as property, equipment, or inventory, can be used as collateral to secure a loan. If the borrower defaults, the lender can seize and sell the collateral to recover the loan amount.
- Co-signers: A co-signer with good credit agrees to share responsibility for repaying the loan. This additional guarantee can make the loan application more favorable to lenders. However, it’s crucial to consider the potential risks to the co-signer’s credit and personal assets.
When considering these options, it’s essential to carefully evaluate the risks and potential consequences, such as the loss of collateral or strained relationships with co-signers in case of default.
Loan Options for Bad Credit Borrowers
SBA Microloans
The Small Business Administration (SBA) microloan program provides loans up to $50,000 to help small businesses and certain not-for-profit childcare centers start up and expand. The average microloan is about $13,000. SBA provides funds to specially designated intermediary lenders, which are nonprofit community-based organizations with experience in lending as well as management and technical assistance. These intermediaries administer the Microloan program for eligible borrowers.
Each intermediary lender has its own lending and credit requirements. Generally, intermediaries require some type of collateral as well as the personal guarantee of the business owner. Microloans can be used for a variety of purposes that help small businesses expand, such as working capital, inventory, supplies, furniture, fixtures, machinery, and equipment. However, proceeds from an SBA microloan cannot be used to pay existing debts or to purchase real estate.
To apply for a microloan, work with an SBA-approved intermediary in your area, as SBA-approved lenders make all credit decisions and set all terms for your microloan. Loan repayment terms vary according to several factors, including the amount, planned use, lender requirements, and needs of the small business owner, with a maximum repayment term of six years. Interest rates typically range between 8%-13%, depending on the intermediary lender.
If you need a relatively small loan to start or expand a business and cannot qualify from most other sources, an SBA Microloan may be a suitable option, especially for businesses owned by veterans, women, minorities, or low-income individuals. While the loan amounts are relatively small, SBA Microloans offer longer repayment terms than most business loans for new businesses, often up to six years, making the monthly payments more affordable. Additionally, the interest rates are generally lower than many other bad credit business loan options, with an average rate of 6.5% in FY2020.
However, it’s important to note that SBA Microloans may be challenging to find, as the non-profit lenders that make these loans often serve limited geographic areas and may not be available in your area. Additionally, the maximum loan amount of $50,000 may not be sufficient for businesses requiring larger funding amounts to expand and grow.
Short-term Loans
Bad credit business loans are often available to business owners with personal credit scores considered bad to fair (FICO scores of 300 to 669). Some options like SBA loans offer low-cost capital, while many other types of business loans for bad credit often come with lower loan amounts, higher interest rates, and shorter repayment terms compared to traditional loans available to people with the best credit.
Lenders like Fundible offer various types of business loans, including term loans, business lines of credit, SBA loans, and equipment financing, with accessible minimum requirements such as a personal credit score of 450 and annual revenue of $100,000. Similarly, BusinessLoans.com is more likely to match candidates with a personal credit score of 600, annual revenue of $100,000, and at least six months in business.
Other lenders like LoanBuilder-PayPal offer short-term loans with terms between 17 and 52 weeks, requiring a minimum credit score of 580 and providing funding as soon as the next business day. OnDeck is another option for repeat loans, allowing borrowers to apply for more money after paying back half of their original loan, accepting minimum credit scores of 625, and offering same-day funding for businesses with over a year in operation, a business bank account, and at least $100,000 in annual revenue.
Business Lines of Credit
A business line of credit can provide business owners with funds within one business day after approval, often requiring a minimum credit score of 600 and six months of time in business, with a maximum limit of $150,000 and repayment terms of 12 or 24 weeks. Payments on these lines of credit are typically not reported to business credit bureaus.
Lenders like Lendio offer business lines of credit as a flexible financing option for small business owners with bad credit, requiring only a 600 credit score and no obligation to use all of the funds, with no fees for unused funds. This can act as a safety net for businesses, providing access to funds when needed without incurring costs for unused credit.
Business lines of credit can be secured or unsecured, with secured lines often offering higher credit limits and lower interest rates due to the collateral involved, such as real estate, equipment, or inventory. Unsecured lines of credit rely primarily on the borrower’s creditworthiness and finances, potentially resulting in lower credit limits and higher interest rates.
When applying for a business line of credit with bad credit, lenders may consider factors such as personal and business credit scores, existing loan obligations, and the ability to provide collateral or co-signers. While approval may be challenging, some lenders may be understanding of situations that led to a low credit score and may offer less favorable terms, such as higher interest rates or stricter repayment conditions.
Invoice Financing
Invoice financing, also known as invoice factoring, is an affordable solution for businesses with bad credit or no credit to access working capital. Unlike traditional loans, invoice financing does not involve new debt, repayment, or interest rates. Instead, it provides access to working capital based on the creditworthiness of the business’s customers.
In invoice financing, businesses sell their accounts receivable (unpaid invoices with delayed payment terms) to a factoring provider to access immediate capital. The factoring provider buys the unpaid invoice for a slightly discounted rate, advancing a percentage of the cash upfront, typically up to 97%. Once the customer pays the invoice at the end of the payment term, the factor advances the remaining amount to the business, less the factoring fee.
A significant benefit of invoice financing is that it helps businesses build or establish their credit by providing consistent cash flow to stay on top of operational expenses or pay off existing debts. Additionally, invoice factoring companies provide free credit checks on all customers, preventing businesses from working with bad debtors and risking non-payment.
Unlike traditional bank loans, which can take months for approval, invoice factoring companies can approve businesses and start funding invoices in as little as one business day, providing immediate access to working capital. This makes invoice financing an attractive option for businesses with bad credit, as factoring providers are unlikely to need to run a credit check and instead base their decision on the creditworthiness of the business’s customers.
Conclusion
Navigating the complex landscape of securing business loans with bad credit can be challenging, but with the right strategies and perseverance, it is achievable. By understanding the impact of poor credit, exploring various loan options, and implementing proactive measures to improve creditworthiness, businesses can unlock the funding they need to thrive and grow. Seeking guidance from financial advisors and leveraging resources like SBA programs can also provide valuable support throughout the process.
Ultimately, securing a business loan with bad credit requires a multi-faceted approach and a willingness to explore alternative lending avenues. By staying committed to responsible financial practices and credit rebuilding efforts, businesses can gradually improve their creditworthiness and gain access to more favorable loan terms in the future. The path may be challenging, but with determination and a strategic mindset, businesses can overcome the hurdles of poor credit and pave the way for long-term success.
