Why Using Personal Credit to Grow Your Business Can Ruin Your Credit
Entrepreneurs are in a league of their own. To find success, you must build strong relationships with clients, vendors, and mentors. Maintain a can-do spirit and find creative solutions to keep the business going during economic shifts. It is not a venture for the faint of heart.However, the blessings are abundant. You gain financial freedom, eliminate glass ceilings, and say when and where you will work. You can set your own terms and soar as high as your dreams will carry you. The truth is starting a business is hard. Nearly 80% of businesses fail within the first 18 months, with the primary reason, because the company runs out of cash. Knowing when and how to add debt can be the difference between thriving or dying. For many business owners, the most obvious place to get money for corporate needs is through personal credit sources. The Canadian Federation of Independent Business estimates that 30% of entrepreneurs regularly use their personal credit card.
Unfortunately, you could ruin your credit in the process.
Adding business debt to personal credit balances can crush your credit score. FICO, the main provider of credit scores in the industry, considers revolving balances on credit cards and other lines of credit, as 30% of your overall score. If you max out personal credit cards, buying business goods and services, your score could fall as much as 100 points.
Inability to Increase Personal Credit
The other major issue occurs when you need to apply for a personal loan. Want to buy or refinance your home, or purchase a new vehicle, the lender will now consider all business debt balances, because they are on your personal balance sheet.
Lenders use the debt to income ratio to decide you much money you can borrow. They calculate this percentage by dividing monthly debt payments by monthly income. For example, if you owe $2,000 a month in debt payments and earn $5,000 per month of income, you have a debt-to-income ratio of 0.40%. Adding business expenses to personal accounts can lead to a loan decline due to a high debt-to-income (D/I) ratio.
Credit Bureau Reporting
Not all company credit reports only to business credit bureaus. Choosing to gain credit through lenders which report to both the personal and business credit bureaus can have the same effect on your credit, as buying with personal credit resources.
Liability for Debt
Whether you buy through personal or business accounts, you remain personally liable for the debt. Lenders require a personal guarantee to obtain business debt and could review personal and business reports before extending credit to the company. While incorporating, rather than operating a sole proprietor, can reduce liability from lawsuits, it does not protect you from debt obligations. Even lenders which typically only report to the business credit bureaus will report to the personal credit bureaus, in the event of a loan default.
Benefits of Business Credit
Business credit cards tend to offer higher limits and can shield debt from your personal credit report, allowing you to borrow independently for business and personal needs. Using business credit will also strengthen your score as you build a history of good debt management.
When you use personal credit for business purposes, it has a negative impact on your personal credit, even when you pay bills on time. Dependence on personal credit also hurts the business because you do not establish company credit, which impacts business credibility and strengthens finances, should you need funding in the future.