How to Avoid a Credit Downgrade on Your Small Business

Last Updated Aug 25, 2011 5:01 PM EDT

What do Walt Disney, Milton Hershey, and Henry Heinz all have in common? They all, at one time, filed bankruptcy. There are scores of famous people who have survived bankruptcy and gone on to become wildly successful.

That's the good news. The bad news is that once it happens, it's both a lengthy and expensive process to restore your credit.

It all starts with your score
Credit scores do more than just affect your ability to get credit: They also affect your bottom line. Credit scores can have an extraordinary impact on the cost of doing business in areas as diverse as vendors' terms and the rates you pay for insurance to, of course, the cost of money.

To illustrate, we'll borrow an example from the housing market. On a $300,000, 30-year fixed rate mortgage, a borrower with poor credit could easily pay an extra $600 per month than someone with a good credit score. That's $7,200 more every year. Over the course of the loan that adds up to an additional $216,000.

If that was a business loan, and you had a 10 percent profit margin, you would need more than $2 million in sales to cover the additional interest expense.
What determines your score
To state the obvious: Making your credit payments on time is the single biggest contributing factor to your credit score.

Not so obvious is that no credit is just as bad as poor credit. It's an admirable goal to try to build a business without being beholden to a bank, but it could come back to hurt you: If you have no debt, banks and other entities that you may wind up dealing with as you grow may perceive you as a higher risk than if you manage credit responsibly.

Because the length of time you have had credit affects about 15% of your credit score, closing a credit account will lower the average age of your accounts and impact your rating. You're better off using a credit card at least once a month and paying the balance off rather than closing the account entirely.

As with most things, the near past is the best predictor of the near future. Therefore, late payments within the last six months wreak the most havoc while those more than two years old have the smallest impact. If the recent economic storms battered your credit, don't lose time in restoring it.
Monitor your score
In his free e-book "What your Bank Won't Tell You About Credit," credit expert and author Philip Tirone cites a scary stat from the U.S. Public Interest Research Group survey: "Almost 80 percent of people have errors on their credit reports, 25 percent of which are serious enough to cause a person or business to be turned down for a job or loan."

If you haven't monitored you credit score on an ongoing basis now is the time to start.

Request your personal credit report from each of the three consumer reporting companies (Equifax, Experian, and TransUnion) once per year (for free) at AnnualCreditReport.com. This is the only website authorized by the FTC under The Fair and Accurate Reporting Act (FACT). There are lots of other websites that offer free credit reports, but they'll probably pitch their other services as well.

Dunn & Bradstreet is the go-to site for business credit reports. They have all sorts of options depending on how much information you want and how much you are willing to spend.

After you've received your reports, check carefully for any credit that does not belong to you and any erroneous reporting.

Common errors include:

  • Accounts that aren't yours
  • Reports of late payments when you really paid on time
  • Bankruptcies older than 10 years
  • Accounts that were wiped out in bankruptcy but are listed as still due
  • Other negative information that's older than seven years (The clock typically starts 180 days after the account first went delinquent)
Follow the instructions provided with your report to dispute any errors found.

Prepare to repair
Rule #1: Get current and stay current. The longer you pay your bills on time after being late, the greater the increase in your score. The impact of past credit problems fades as time passes and as recent good payment patterns show up on your credit report.

Rule #2: Talk to your creditors. That you communicate can be as important as what you communicate. In our experience, most companies will work with you and appreciate your commitment to pay them back. It's when lenders don't hear from you for several months that bad things begin to happen.

Rule #3: Monitor regularly. Sticking your head back in the sand will do you no good. Know where you're at and measure improvement. The biggest strides can be made in baby steps.

Bad credit can happen to just about anyone. As with any adversity, the true test is not the bad credit but in how a business owner deals with it. Just ask Henry Ford or Donald Trump. (Yup, both filed bankruptcy.)

Flickr photo courtesy of BookMama, CC 2.0

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