Applying for small business credit can be time-consuming and frustrating. Research from the Federal Reserve Bank of New York shows the average small business owner spends more than half a standard work week (26 hours) researching and applying for financing.
Unfortunately, putting in that time and effort doesn’t always pay off. The Nav American Dream Gap Report survey found that 45% of small business owners whose applications for financing were declined said they were turned down more than once. And research from the Federal Reserve’s 2014 Joint Small Business Credit Survey found that in the first half of 2013, a quarter of firms with employees and nearly a third (31%) of those without employees didn’t even bother to apply because they didn’t believe their applications would be approved.
While no one wants to be rejected when they apply for credit, small business owners are at a particular disadvantage because major consumer protection laws don’t always apply to entrepreneurs seeking financing for their ventures.
Here are three “gotchas” that may come as a surprise:
1. You Don’t Get a Free Credit Report or Credit Score
Consumers who apply for credit and are turned down or charged more because of information in their credit report must be given a disclosure telling them which credit reporting agency supplied their report to the lender so they can order a free copy. When a credit score is used in the decision, the applicant will also be given their score—the actual one the lender used—along with the main factors affecting it. These disclosures give consumers the opportunity to check credit reports for errors, and to understand why they didn’t get the credit they wanted.
But there are no similar freebies for business owners when their business credit reports or scores are used to turn them down for financing. It’s no surprise then, that in Nav’s survey, nearly half (45%) said they didn’t know they had business credit reports, and the majority (72%) didn’t know how to get that information.
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2. You May Ding Your Personal Credit Scores
With some types of small business credit, including business credit cards, lenders rely heavily on an owner’s personal credit scores, rather than business credit scores. That credit check will result in an inquiry of the owner’s personal credit reports, which in turn can hurt their scores. Most inquiries only shave a few points off one’s scores (usually in the range of 2 to 7 points), and typically only inquiries made in the previous 12 months are included in credit score calculations.
But if a business owner is shopping for credit and applies with multiple lenders—or if a broker “shops” applications on the owner’s behalf—multiple inquiries could result in a significant drop in the owner’s personal credit scores, and make it that much more difficult to get approved.
3. You May Not Know Why You Were Turned Down
In the Nav survey, 23% of business owners surveyed said they didn’t know why they were turned down for small business financing. When your application for a consumer loan is rejected, you’ll know. You’ll get the credit report and credit score disclosures mentioned above, plus additional information about your rights when you are denied credit.
With business credit, it can be less clear. Lenders have to provide you with the main reasons your application was rejected, but they are often allowed to provide them in writing or verbally—and in some cases, they don’t have to provide them directly. Instead they can provide instructions on the credit application that explain how to request that information. The applicant who doesn’t take note of those details or doesn’t follow up, may miss the opportunity to find out why they didn’t qualify.
Before You Apply for Small Business Credit
How can you make the process of shopping for commercial credit easier and less stressful? Review your credit reports and scores before you apply so you know where you stand. Make sure you check your business credit scores and your personal credit scores, as they may be reviewed by lenders for certain types of small business financing applications.
It also helps to understand the lender’s qualifications before you apply so you don’t waste time applying for loans you aren’t likely to get. For example, if your personal credit is bad, you want to look for financing options that don’t require good personal credit. (“The Ultimate Guide to Financing Your Business in 2017” is a free e-book from Nav that explains lending options and requirements for major types of loans as well as specific lenders.)
If you are turned down, make sure you find out why. Some lenders are willing to reconsider if a borrower presents a good reason for reevaluating their application. At a minimum, you may get helpful information about ways you can improve your credit or finances before you apply again.