Though more affordable than in times past, starting a business isn’t cheap. Until your business starts turning a profit, it will be your responsibility to pay for everything from leases and utilities to equipment and payroll. Depending on the type of business you’re starting, that could set you back thousands of dollars. This is why most opt to take out a business loan.
A business loan is a popular and convenient funding source for startups. They provide you with the funds you need upfront to manage and operate your business allowing you to pay it back (with interest) over time. An important factor to make note of, however, is that your personal credit will be used to determine if and how much you can borrow.
No Established Business Credit
When you’re just starting out, you don’t have any available business credit. This leaves a huge risk for lenders. They have no idea whether or not your business generates the capital necessary to repay the loan in full. Therefore, they’ll rely on your personal credit to make a final decision.
Can you be trusted with a large sum of cash? This is a question that lenders often ask before approving an application. Your personal finances give them insight on your credibility as a borrower. They’ll look to see what types of loans you’ve borrowed in the past, whether or not you kept up with payments, and how long it took you to pay them off. If your financial history shows that you’re responsible with your money, lenders are more inclined to give you the loan.
Another reason your personal finances matter when trying to get startup funding is your assets. Should you default on the loan, lenders want to know how much of a loss they’ll be dealing with. They want to know if you have enough assets to cover part or all of the outstanding balance. Such assets might include a home, car, savings account, or stocks. This way, if you default, they can request that the judge liquidate your assets to cover the debt.
Hopefully, you have another source of income to rely on until your business gets off the ground. This is not only imperative to your survival but important to lenders. It can take months before you start seeing a profit. There’s also the reality that your business may fail. If that happens, lenders want to know that you have a financial source to repay them from. Your personal finances can give them details on your income source and how much you’re making. It is often best to stick with the same job or side hustle when applying for a loan as having several jobs over the course of a year can appear risky to lenders.
Debt to Income Ratio
Another reason lenders look at your personal finances to make an application decision is your debt to income ratio. If you presently have a lot of bills, they’d be less inclined to loan you the money. This is because it may prove to be too much of a burden for you down the line. So, if you have a lot of credit card bills, medical bills, or personal loans, you may want to work with a debt consolidation firm to get back on track and lower your debt. Though it can take some time for your credit history to improve, it’s better to reduce your debts now then have to pay for it big time later on.
Although the loan you’re trying to obtain is to start a business, your personal finances will play a significant role in the lender’s decision to approve. Since your business has no track record or financial footprint, you’re ultimately taking on the responsibility personally to repay the loan in full. That’s why it is imperative to do an evaluation of your finances before applying. If necessary, begin taking steps to improve your credit to increase your chances of getting the funds you need to start your business.