Understanding the impact of credit score on your borrowing power: A guide for business owners

For business owners, access to capital is essential for growth, whether it’s for expanding operations, purchasing new equipment, or managing cash flow. One of the key factors that lenders consider when evaluating loan applications is the borrower’s credit score. Understanding how your credit score impacts your borrowing power can help you better prepare for financing opportunities and secure the funds your business needs. In this guide, we’ll explore the relationship between credit scores and borrowing power, and provide insights on how business owners can improve their credit profile to enhance their financing options.

What is a credit score?

A credit score is a numerical representation of an individual or business’s creditworthiness. In Australia, credit scores typically range from 0 to 1,200, with higher scores indicating better creditworthiness. Lenders use credit scores to assess the risk of lending money, and a higher score generally increases the likelihood of loan approval and better loan terms.

Key factors influencing your credit score

• Payment history: Consistently making on-time payments on loans, credit cards, and other credit accounts positively impacts your credit score.
• Credit utilisation: The ratio of your outstanding credit balances to your credit limits. Lower utilisation rates are better for your credit score.
• Credit history length: A longer credit history with responsible credit management can boost your credit score.
• Credit mix: A diverse mix of credit types (e.g., credit cards, mortgages, business loans) can have a positive effect on your score.
• Recent credit inquiries: Frequent applications for new credit can negatively impact your credit score.

How credit score impacts your borrowing power

Your credit score plays a significant role in determining your borrowing power—the amount of money lenders are willing to lend to you and the terms they offer. Here’s how your credit score can influence various aspects of your borrowing experience:

1. Loan approval likelihood

Lenders use your credit score as a primary factor in deciding whether to approve your loan application. A higher credit score signals to lenders that you are a low-risk borrower, increasing your chances of loan approval. Conversely, a lower credit score may result in your application being denied or approved for a lower loan amount.

2. Interest rates

Your credit score directly influences the interest rate you’ll be offered on a loan. Lenders reserve their best interest rates for borrowers with high credit scores. Lower interest rates mean lower monthly payments and less interest paid over the life of the loan, which can save you a significant amount of money.

Example:

• High credit score: Business owner A has a credit score of 800 and secures a business loan with an interest rate of 4%.
• Low credit score: Business owner B has a credit score of 600 and secures the same loan with an interest rate of 8%.

Over a 5-year loan term, Business owner A will pay significantly less in interest than Business owner B.

3. Loan amount

Lenders are more likely to offer higher loan amounts to borrowers with strong credit scores. This is because a high credit score reflects your ability to manage debt responsibly. For business owners looking to secure large sums for significant investments, a higher credit score can be crucial in obtaining the necessary funding.

4. Loan terms

In addition to influencing loan amounts and interest rates, your credit score can also impact the terms of the loan, such as repayment period and fees. With a high credit score, you may have more flexibility in negotiating loan terms that suit your business’s cash flow and financial planning.

5. Access to diverse financing options

A strong credit score opens up a wider range of financing options, including business lines of credit, equipment financing, and commercial mortgages. This diversity allows you to choose the financing solution that best meets your business needs.

Improving your credit score to enhance borrowing power

If your credit score isn’t where you’d like it to be, there are steps you can take to improve it. By proactively managing your credit, you can enhance your borrowing power and secure better financing options for your business.

1. Monitor your credit report

Regularly reviewing your credit report allows you to stay informed about your credit status and identify any errors or discrepancies that may be affecting your score. In Australia, you can obtain a free copy of your credit report from major credit reporting agencies like Equifax, Experian, or illion.

Action items:

• Dispute inaccuracies: If you find any errors on your credit report, promptly dispute them with the credit reporting agency to have them corrected.
• Monitor regularly: Set up alerts or reminders to review your credit report at least once a year.

2. Pay your bills on time

Consistently paying your bills on time is one of the most effective ways to improve your credit score. Late payments can have a significant negative impact on your score, so it’s important to prioritise timely payments on all your accounts.

Action items:

• Set up automatic payments: Automating your payments can help ensure you never miss a due date.
• Create a payment schedule: Use a calendar or financial management app to keep track of payment deadlines.

3. Reduce your credit utilisation

High credit card balances can negatively impact your credit score. Aim to keep your credit utilisation ratio below 30% of your available credit limit. Paying down existing balances can quickly improve your score.

Action items:

• Pay down balances: Focus on reducing balances on credit cards and other revolving credit accounts.
• Distribute debt: If you have multiple credit cards, consider spreading the debt across them to reduce the utilisation on each card.

4. Avoid applying for new credit unnecessarily

Each time you apply for new credit, it results in a hard inquiry on your credit report, which can temporarily lower your score. Avoid applying for new credit accounts unless absolutely necessary, especially before applying for a business loan.

Action items:

• Limit new applications: Only apply for new credit when it’s essential for your business operations.
• Consider alternative financing: Explore options like business lines of credit that may not require a hard inquiry.

5. Keep older credit accounts open

The length of your credit history is an important factor in your credit score. Keeping older accounts open, even if you don’t use them regularly, can contribute positively to your credit score.

Action items:

• Maintain old accounts: Avoid closing old credit card accounts, as they contribute to the length of your credit history.
• Use older accounts occasionally: Make small purchases and pay them off to keep older accounts active.

The long-term benefits of a strong credit score for business owners

A strong credit score is not just beneficial for securing a single loan; it can have lasting positive effects on your business’s financial health. With a higher credit score, you’ll have greater access to capital, more favourable loan terms, and increased flexibility in managing your business’s growth and operations.

Building trust with lenders

A high credit score builds trust with lenders, making it easier for your business to access financing as needed. This trust can lead to a long-term relationship with your lender, providing ongoing support for your business’s financial needs.

Lower cost of borrowing

By securing lower interest rates and better loan terms, a high credit score reduces the overall cost of borrowing, freeing up more of your business’s resources for investment and growth.

Increased financial stability

Access to diverse financing options and larger loan amounts can help your business maintain financial stability, even during challenging economic times. A strong credit score acts as a financial safety net, ensuring you can continue to operate smoothly and seize new opportunities.

Get started

Understanding the impact of your credit score on your borrowing power is essential for business owners looking to secure the best financing options. By taking steps to improve and maintain a strong credit score, you can enhance your borrowing power, reduce your cost of borrowing, and position your business for long-term success. Whether you’re planning to expand your operations, invest in new equipment, or manage cash flow, a strong credit score will give you the leverage you need to achieve your business goals.

For more information on how your credit score can impact your borrowing power and to explore financing options tailored to your business needs, visit our Borrow page.

Learn more

For additional resources and information on managing your credit score and borrowing power, explore these helpful links:

• How to improve your credit score before applying for a loan: A guide for property owners

By proactively managing your credit and understanding its impact on your borrowing power, you can secure the financing your business needs to thrive and grow.