A Business Loan with Bad Credit Not a Deal-Breaker
Before FinTech revolutionized small business lending, traditional banks were the go-to source for a business loan. Having bad personal credit pretty much precluded a business owner from being able to secure funding.
However, the Great Recession changed everything. Ironically, it led to an eventual opening of the floodgates. During the post-recession “credit crunch” of 2008-10, bank lending dried up – even for companies with good credit who had deposit relationships with banks. People started looking for other sources of capital, and the internet made it easy to search for funding.
Small business owners who otherwise would have gone to their bank discovered alternative (non-bank) lenders that they found online. Because these lenders were not handcuffed by banking regulations, they were more willing and able to provide capital, albeit at higher interest rates that reflected the increased risk of loaning money to individuals with poor credit histories.
Things to Consider Before You Apply for a Business Loan with Bad Credit
If you can put off applying for a loan, take action to repair your credit history:
- Check your credit report from a free service, such as FreeCreditReport.com, to make sure they are accurate and that past blemishes that have been resolved are no longer hurting you. (All derogatory remarks on a credit report have an “expiration date” and must be removed from your report after the date passes.) Make regular, on-time payments of existing debt. If your cash need is not immediate, begin working to pay off your creditors.
- If you qualify, open a business credit card, make small purchases, and pay the card off on-time and in full for several months. This will help establish a track record of prompt payments and will build your credit rating. In many cases, a business credit card can be secured with a credit score of 630 or higher.
- If you are eligible, try securing a business line of credit, which is a lump sum of money available for usage as needed. Interest is charged only on the amount of credit actually used. Often you can secure a business line of credit that is about 10 to 15 percent of your annual revenue. The interest rate charged is typically lower than the rates charged by credit card companies.
Companies that are in a hurry for funding but are hampered by a bad credit history, might consider invoice financing or “factoring.” Essentially a business borrows against its own accounts receivable (unpaid invoices). Lenders are purchasing your receivables at a discounted price in exchange for providing capita. The interest rate charged will be largely determined by the value of the money you are owed by your customers.
Another source of funding for companies that have bad credit is merchant cash advance. With this type of financing, a business is able to secure capital in return for a percentage of daily credit card receipts. For instance, if a company needs to borrow $20,000 to cover some unforeseen expenses, a merchant cash advance lender can provide it and then will take a portion of your credit card sales until $24,000 is paid. The advantage of this type of borrowing is that if your company has a good day at the cash register, a bigger portion of the debt is repaid. But if you have a slow day, the amount of repayment is less.
Merchant cash advances are suitable for business owners who have a steady flow of credit card transactions. Restaurants and retailers are two common types of businesses that use merchant cash advances. Typical business owners who qualify have a credit score of 525-550 and $150,000-$200,000 in annual revenues.
The advantages of merchant cash advances are:
- MCA financing is perhaps the fastest loans available. The average turnaround for securing funding is just a few days.
- There is a limited amount of paperwork involved since the decision is based heavily upon the credit card records of the firm.
- Companies with poor credit can get approved.
- MCA funding is unsecured, meaning that you do not need to pledge collateral and are not personally liable in the event the company is unable to repay the loan.
- Payments are directly related to health of the business and are made as a percentage of daily sales. Thus, a borrower pays pay less when sales are slower and more when business is good.
On the flip side, there are several cons:
- MCA loans are expensive. The annual percentage rate, or total annual borrowing cost with all fees and interest included, may be 30 to 40 percent or more! The amount charged depends on the lender, the size of the advance, any extra fees, how long it takes to repay the advance in full, and the strength of the company’s credit card sales.
- There are no pre-payment savings.
- There is little or no regulation since MCA loans are not covered by government regulation like traditional bank loans.