Businesses both small and large take on commercial debt as a way to finance projects, expand, or even to make payroll. Commercial credit cards are also popular among businesses due to the many conveniences and perks they offer.
But if you’re a small business owner who’s considering applying for commercial funding, there are a number of things you’ll want to consider before filling out any applications. While you’re researching the best rates and most attractive terms available, don’t forget to factor in the impact your new business account might have on your personal credit.
Business or Pleasure: Two Different Credit Reports
As a business owner, your company generally has credit reports that are separate from your personal credit reports. The three major business credit reporting agencies in the United States are Dun and Bradstreet, Experian (Business Credit), and Equifax (Business Credit), though there are others.
Of course, your business credit reports could be blank slates if you’ve never established commercial credit in your business name.
Business debts typically do not show up on your personal credit reports, because they aren’t personal debts. This is good news, since if those commercial debts did appear on your personal credit reports, they could lower your personal credit score and blow up your debt-to-income (DTI) ratio. Either of these could make it more difficult for you to qualify for personal financing in the future, such as a mortgage or car loan.
However, there are certainly some exceptions to this rule, and sometimes commercial accounts do find their way onto personal credit reports.
One of the most important questions you should ask a lender before applying for a new business credit card or business loan is whether the account will be reported to the three consumer credit reporting agencies (Equifax, TransUnion, and Experian). If the answer is yes, then you may want to consider finding a different lender for your business financing needs.
You may be wondering: How in the world can a business debt end up on a personal credit report? Here’s how:
The Personal Guarantee
Many business credit applications contain language that will personally obligate you to be liable for your company’s debt. This is called a “personal guarantee,” or a “PG” for short.
If you sign a personal guarantee, then you’re likely agreeing to pay back the borrowed funds yourself in the event your company defaults.
Additionally, when you sign a personal guarantee, you typically give permission for the lender to report the account activity to your personal credit reports — though many lenders only report commercial accounts to the personal credit reporting agencies if the accounts go into default.
As a business owner, it’s in your best interest to keep personal debts and business debts separated whenever possible.
If your business can borrow funds and open business accounts with lenders that don’t report to the personal credit reporting agencies, that can be a great way to shelter your personal credit from a host of potential complications (such as high utilization on credit cards, too many accounts with balances, and excessive credit inquiries).
There are, however, other downsides to consider where business debts are concerned. When you take on a commercial debt, you typically don’t enjoy the same protections afforded to you when you take on consumer debts.
CARD Act protections, for example, will not apply to business credit card accounts. Yes, there’s other legislation that may protect you when it comes to business debt, but protections are considerably less impressive for the commercial debtor when compared to the protections enjoyed by consumers.
And finally, the lender can pursue you, personally, for repayment of defaulted debt, including credit reporting and even litigation.
Alternatively, the upside is that you may not be able to qualify for business credit without putting your personal credit reputation on the line. While that’s risky, there may be no other way to fund a fledgling business idea.
But while there are likely many compelling stories of successful businesses started on the back of someone’s personal credit card account, there are just as many, if not more, that end with failed business debts weighing down the owner’s personal credit reports.
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John Ulzheimer is an expert on credit reporting, credit scoring, and identity theft. He has written four books on the topic and has been interviewed and quoted thousands of times over the past 10 years. With time spent at Equifax and FICO, Ulzheimer is the only credit expert who actually comes from the credit industry. He has been an expert witness in over 230 credit related lawsuits and has been qualified to testify in both federal and state courts on the topic of consumer credit.