Over the past ten years, I have analyzes the importance of small to medium-sized enterprises (SMEs) and its owners to understand how a personal credit score [commonly referred to as FICO score] can make an enormous difference on the availability of financing businesses. FICO scores are used by banks, lenders and funders when performing due diligence on a business loan. SME owners are often not aware of the widespread use of personal FICO scores in the decision making process for their business loan.
To say last year was two sides of a coin would be an understatement. The United States economy came into 2020 on a roll. Consumer confidence, spending and equity markets in the United States were humming and the outlook for the balance of 2020 was bright. We know the rest of the story. The deadly COVID-19 pandemic destroyed countless lives and the economy slid to levels not seen since the Great Recession of 2008 to 2009. Never before seen things happened seemingly overnight; stay at home restrictions, thousands of SME closures, record unemployment and government intervention at unprecedented amounts of loans, stimulus checks and other programs.
A logical thinker would assume that the average FICO score for Americans would have to drop. However, the national average FICO score actually increased to 711. This underscores the power of the relief measures rolled out nationally to combat the impact of the pandemic in the United States.
Why did this seemingly impossible feat occur? It happened because several of the key FICO score components, including credit utilization and payment history improved; with actual utilization rates and late payments decreasing at a record pace. Improvements of this kind add to consumers’ overall credit health and can cause scores to rise in a short period of time. So what this means in plain English is that the scores improved largely due to the fact that consumers had nowhere to spend money [other than online] and that personal financial health is worse now than ever.
I encourage you to take a few moments to read through Experian’s 2020 Consumer Credit Review.
I am often asked why it important for SME owners to manage their personal credit. There is a correlation between your FICO score and the cost of what you will pay for any loan that you are applying for. A higher score can help you secure better terms and lower interest rates available. We encourage all SME owners to improve their credit scores before they apply for a loan or line of credit. Methods to improve a credit score include:
- Know your FICO score. Credit card companies may provide your score as part of their monthly statements.
- Pay your amount due on time. This makes you an attractive customer to a potential lender.
- Pay down your balance so it is a 10% or less of your credit limit. For example, if your credit limit is $10,000 – only charge up to $1,000 on that card. This is the credit utilization metric and a lower utilization percentage is better. This also means that maxing out your credit card will lower your score.
- Keep your credit inquiries to a minimum. Know the difference between a hard pull and a soft pull (hint: a soft pull doesn’t impact your credit score). And be mindful of which method is used by your lender (we only use a soft pull).
There are products in the marketplace that may assist in increasing your score. I recommend you research these “boost” services before signing up for a specific one. Typically, these products add secondary information to your credit score consideration increasing your reputation and boosting your score. Resist the urge to apply for credit unless you really need it for some legitimate purpose. You should apply only for credit when you really need it to acquire a large item, piece of equipment or other similar situations.
The more you know about your financial position, the better you will understand how a lender makes a decision. The goal is to hold a strong FICO so you can negotiate the best terms to grow your SME profitably. Good luck!
Mark Mandula is National Sales Manager of Florida-based alternative finance firm United Capital Funding. The firm provides commercial finance opportunities to small businesses with B2B and B2G relationships by funding accounts receivables. Learn more at ucfunding.com.