Credit Reporting and Scoring
Before a company lends you money, it wants to know that you're capable and willing to repay the debt. It can do this by reviewing your finances, including your bank account balances. It can also look at your history of repaying other debts by reviewing your credit reports.
Credit reports haven't always existed, at least not with the same formalized systems that we have today. There was a time when many people lived in small towns, and the local grocer or supply store might know you and your family and sell you goods on credit (meaning, you receive the products now and can pay for them later), based on your reputation.
However, as cities grew and it became easier to travel, businesses needed a way to evaluate a stranger's ability and willingness to repay a loan. Some types of merchants worked together to create lists of trustworthy buyers. For example, there might be merchant association for all the lumber sellers in a city, and they would keep a list of the contractors who paid (or didn't pay) bills on time.
In the mid-1800s, a new industry was born — credit reporting. The credit reporting companies would research people and businesses, keep a record of their payment history and sell access to credit reports. Fast forward to today, and international credit bureaus are using more advanced technology to collect information, organize the data and sell credit reports around the world.
Why is this important to small business owners? Because a good credit history could help you:
- Negotiate with your suppliers
- Pay less for insurance
- Qualify for lower interest rates and higher loan limits when you borrow money
- Take out a business loan without impacting your personal finances
For many small business owners, their personal and business credit can be important to the financial management of their business. However, personal and business credit systems may be completely separate, so it's good to learn about how both systems work.
Most of the information in credit reports is voluntarily reported to the credit bureaus by other companies. For example, a credit card issuer might choose to report your payments to the consumer bureaus, or your small business's vendor might report if your business didn't pay for its supplies within the agreed-upon time.
Many creditors report both positive and negative activity related to your account (i.e., your on-time payments and missed payments). There are some exceptions, though. Utility, phone, internet and rent payments generally don't get reported to the bureaus if you're paying your bills on time. But if you stop making payments and your account gets sent to collections, the collections account could get reported to the bureaus and hurt your credit scores.
The bureaus collect all this information from different types of creditors and public records, and then combine the information that's associated with an individual or business to create a credit report.
Credit reports can be important for two reasons. First, they're the basis for credit scores, which can give lenders and other businesses an easy way to evaluate you or your business.
The credit report itself may also contain a lot of information that lenders can review before approving or denying your application. And businesses may review each other's business credit reports before deciding to work together. As a result, even if you have a high credit score, you may be denied for a loan or contract based on something in your credit history.
Personal credit reports
In the United States, there are three main, nationwide consumer credit bureaus: Equifax, Experian and TransUnion. Federal laws and bureaus' policies dictate what can and cannot be in your personal credit reports, limit who can view your credit reports, guarantee your rights to access copies of your reports and allow you to dispute any errors you find.
Your personal credit reports contain information about you and the accounts you've opened in your name, such as:
- Identifying information. Your personal information can include your name, Social Security number, date of birth and address. Your credit report may also have information about past addresses, along with current and former employers.
- Accounts. A list of all of your credit accounts that are reported to the bureau, including different types of loans and credit cards. The accounts, also called tradelines, could have a variety of information associated with them, including the date each account was opened, the current balance and your payment history with the account.
- Collections. A company may send your account to collections, tasking another department or hiring a different company to collect your debt, if you haven't paid your bills. The collection account may show up in a different section of your credit reports.
- Credit checks. When someone checks your credit, a record of the credit check (called an inquiry) is added to your credit reports.
- Public records. The only information the credit bureaus actively obtain is public record data from the court system, such as bankruptcy filings.
Some information will never be part of your credit reports, such as your religion, ethnicity or income. Additionally, negative information, such as late payments or bankruptcy, must be removed from your credit reports after seven to 10 years.
You can request a free copy of your credit report from each of the bureaus once every 12 months at AnnualCreditReport.com. While your credit reports from the three bureaus are often similar, they may not be identical. For example, you may have a loan with a bank that only reports your payments to Experian and TransUnion. As a result, that account won't be on your Equifax credit report.
If you find an error on one of your reports, such as an account that you didn't open, you can file a dispute with the bureau and it must investigate your claim and either verify, correct or delete the disputed item.
Business credit reports
Credit bureaus also create business credit reports. Some of the bureaus, such as Experian and Equifax, create personal and business credit reports. However, there are also bureaus like Dun & Bradstreet (D&B) that solely focus on business credit.
There are a few steps you may need to take before a business credit bureau can create a credit report for your business. These are detailed on the Business Credit page and include legally creating your business and registering for an Employer Identification Number (EIN) and Data Universal Numbering System (D-U-N-S Number). D&B will use your business' D-U-N-S Number as an identifier to tie your accounts and payments to your business.
Similarly, your business's name and EIN will help the credit bureaus link the correct accounts to your business's credit history. It's like how consumer credit reports are tied to individuals using personally identifying information, such as your name and Social Security number.
Like personal credit reports, business credit reports are filled with information that the bureaus receive or collect. A business credit report may have several sections:
- About the business. Who owns and runs the business and whether the business is part of a larger family of businesses. The section may also have details about when the business was started, how many employees there are, where it's located and its estimated sales for the year.
- Accounts. The business's loans, credit cards and credit accounts with suppliers, along with the payment history and balances for each account.
- Collections. The business's unpaid accounts that have been sent to a collection agency.
- Banking, insurance and leasing. The business's primary bank, whether the business is leasing (i.e., renting) equipment from another business and the insurance companies that have sold insurance to the business.
- Public records. Bankruptcies, judgments (a court order that the business must repay a debt) and Uniform Commercial Code (UCC) filings (when the business has promised something to a creditor in case it can't repay a debt).
- Comparative data. How well a business is doing financially compared to other similarly sized companies in the same industry.
Unlike with personal credit, there's little regulation of business credit reports. For example, anyone can purchase a copy of your business's credit report, while someone needs to have a legally defined “permissible purpose” (such as your permission) to view your personal credit report.
You also aren't guaranteed free access to business credit reports. However, you may be able to buy your business's credit reports from the bureaus, and some companies that aren't credit bureaus may give you free access to some of your business credit reports.
Regularly checking your business credit reports for errors could be a good idea, as an error may hurt your business's creditworthiness or even indicate fraud. If you find an error, you can dispute the information with the credit bureau.
Credit scores are the result of computer formulas (also called credit scoring models) analyzing credit reports and attempting to predict specific outcomes based on an individual's or company's credit history. Many credit scores attempt to determine the likelihood that the person or business will fall behind on a bill.
Credit scores can make it easier to evaluate someone's credit — rather than figuring out how to interpret a credit report, creditors can quickly look at a score and then make a decision.
Generally, a higher credit score means a person or business is more likely to pay bills on time. Having higher credit scores can make it easier to qualify for loans or credit cards with favorable terms and lead to paying less for insurance.
There are both consumer and business credit scores based on consumer and business credit reports.
Personal credit scores
Consumer credit scores are generally based on the information in one of your credit reports. These scores attempt to predict the likelihood that someone will be 90-plus days late on one of their bills. Several companies create consumer credit scores:
- FICO. FICO was one of the first companies to create credit scores based on consumer credit reports, and it's still the industry leader. There are different types of FICO scores, but most of the scores range from 300 to 850.
- VantageScore. VantageScore was started by the three credit bureaus in 2006 and is one of FICO's largest competitors in the United States. The latest VantageScore credit scores also range from 300 to 850, although FICO and VantageScore use slightly different criteria when determining a person's score.
- Custom scores. Many lenders create their own credit scoring models rather than (or in addition to) buying a score to evaluate an application. Custom scores may be based on the information in your credit report along with internal data. For example, if you have a checking account and apply for a credit card from the same bank, the bank might consider how you've managed the checking account.
Business credit scores
Similar to personal credit scores, companies create different types of business credit scores to evaluate businesses. Here are a few of the popular business credit scores:
- D&B Paydex. The Paydex credit score ranges from 1 to 100. A score of 80 indicates the business usually pays bills on time, but you'll need to pay bills ahead of time to get a score above 80. Generally, the Paydex score is used by suppliers to help decide whether they should let you buy supplies now and pay for them later (i.e., buy “on terms”).
- Intelliscore Plus from Experian. The Intelliscore Plus credit score also ranges from 1 to 100. Your business's score will be associated with a risk class, and your score needs to be 76 or higher to be in the lowest (i.e., best) risk class. The Intelliscore Plus credit score is designed to predict the likelihood that a business will fall far behind on a bill within the next 12 months. Generally, lenders use the Intelliscore Plus credit score when evaluating a business's application for a loan or line of credit.
- FICO Liquid Credit Small Business Scoring Service. The FICO Liquid Credit Small Business Scoring Service (SBSS) score ranges from 0 to 300. A high score indicates a business is more likely to pay bills on time. Lenders use this score to review applications for loans and credit lines. If you apply for a Small Business Administration (SBA) 7(a) loan, a popular type of small business loan, the lender will evaluate your application with a FICO SBSS score and you may need a score of at least 140 or 160 to qualify.
How to improve your credit scores
Building credit can take time, and it's best to start early before you need to apply for a loan or credit card. Although the credit scoring formulas can vary depending on the type of credit score, there are some actions you can take that will generally improve your personal or business credit scores.
Personal credit scores
FICO and VantageScore consumer credit scores use similar scoring criteria. As a result, the actions that will improve one of your personal credit scores tend to improve all your personal credit scores. In order, here are the most important scoring factors.
- Pay your bills on time. Try to build a long history of on-time payments with multiple accounts. While a single late payment might not push you all the way down to the poor credit range, having many late payments can definitely hurt your scores. If you don't pay your bills and your account is placed into default or sent to collections, that can hurt your score even more.
- Don't carry high balances. Your current balance on revolving credit accounts, such as credit cards and lines of credit, can also be important to your credit scores. Keeping your balance as low as possible will help your scores. Paying down balances on installment accounts (e.g., a loan that has a fixed repayment period) can also help, although it's not as crucial.
- Have multiple types of accounts. Having a mix of revolving and installment credit accounts can help your credit scores. You may also want to have at least three active accounts on your credit reports to show that you can manage multiple bills at once.
- Limit how often you apply for credit. A lot of recent applications could lower your scores.
Business credit scores
Business credit scores also have different formulas, and if there's a particular score you want to improve, you may want to research how that score is calculated to figure out what specific actions may help. However, in general, the following could improve your business credit scores.
- Pay your bills on time or early. As with personal scores, paying your bills on time is one of the most important scoring factors. However, unlike with personal credit scores, some business credit scores reward you for paying your bills early.
- Don't carry high balances. Having low balances can also help your business credit scores.
- Use multiple accounts that report to the business bureaus. Having loans, credit cards and payment accounts with suppliers on your report (with on-time payment histories) can help your credit scores. You can ask suppliers which business credit bureaus they report to, if they report to any at all.
- Focus on improving your business's finances. Business credit scores may take your business's finances into account as a scoring factor. If you have more money coming in than going out each month and have built your savings, that may be good for your score.
- Work on your personal credit. Some business credit scores, including the Intelliscore Plus and FICO SBSS scores, consider the owners' personal credit as a factor. Your personal credit score could even be one of the most important factors, if your business is brand new.
Using credit wisely
Having excellent personal and business credit scores can help your business in many ways. You may save money on insurance and have more time to repay your vendors. You may also be able to borrow more money at a lower interest rate from lenders and credit card issuers.
However, just because you can get approved for a loan or line of credit doesn't mean you should borrow money. Generally, it's best to borrow money when you have a specific plan for how you're going to use the money, know how the money will help grow your business and are confident that you can repay the debt.