Takeaways:
- Business credit is any lines of credit, financing or vendor accounts that are built under your Business Tax ID (EIN).
- Business credit will help separate all of your business debts from your personal credit.
- Defaulting on a business loan with no personal guarantee will not have any effect on your personal credit.
So you’re getting ready to show off some properties to your new clients. You map out where you’re going and pile into your trusty, but dated, automobile.
It’s about that time you realize the “old girl” isn’t what she used to be. Perhaps a new car would look a bit more professional, but you’re not ready for a new car loan. Maybe business credit is right for you.
What is business credit?
Business credit is any lines of credit, financing or vendor accounts that are built under your Business Tax ID (EIN). Most small to midsized business owners mix their business expenses or credit with personal credit by personally guaranteeing business debt, which affects their personal credit DTI (debt-to-income ratio).
Lenders will use your DTI ratio to determine how much you, as an individual, can borrow under your Social Security number. If your personal credit is loaded with accounts such as your office mortgage, maxed-out “business” credit cards and an auto loan, you might not get approved for the personal loan you seek.
Business credit will help separate all of your business debts from your personal credit.
Business credit could get all the necessities your business needs without the risk of personal guarantees. Drive your clients around in style with a new vehicle or get a new computer for your office all while building your business credit and without putting any pressure on your personal credit.
Why do I need business credit?
Paying for business expenses with your personal finances is never a good idea. Your DTI ratio will go through the roof.
As mentioned before, business credit will allow you to separate your personal expenses from your business expenses while removing the risk of personal guarantees. The goal of business credit is to not have any business debts reporting on your personal credit report.
What happens if you default on a business credit loan?
Defaulting on a personal loan is devastating to your credit. Defaulting on a business loan with no personal guarantee will not have any effect on your personal credit. Only your business credit will be affected.
What are the pitfalls of business credit?
Business owners need to be aware of some of the disadvantages of business credit. Small-business credit cards have been excluded from the Credit Card Act of 2009, which means that you could wind up paying excessive fees and high interest rates.
If there happens to be a personal guarantee, you could damage your personal credit history as well. There is also a real risk of employee abuse associated with business credit cards.
Defaulting on a business credit card or line of credit can also trigger lawsuits.
Generally, if your business is a separate entity, such as a corporation or LLC, the judgment permits the creditors to pursue your business assets but not your personal assets.
S corporations, sole proprietors or partnerships carry the risk of the creditors seeking personal assets as well.
What expenses does business credit cover?
Business credit can cover everything including pens, business cards, vehicles and mortgages. Initially, your first expenses with business credit would be through small-vendor trade lines such as Vista Print or Grainger.
After your company has established a decent business credit profile, you will be able to apply for more extensive loans.
Although you can use anything purchased with your business credit for personal use, you need to check with your insurance agent about potential insurance liabilities of doing so.
It is imperative that all of your vendors and creditors report your experiences to the business credit bureaus. Lack of reporting has been a significant issue for many businesses. Vendors and creditors that do not report your accounts will not build your business credit profile.
Do I need an EIN for business credit?
Yes. In order put these trade lines on your business credit profile your business EIN must be used. The trade line must be attached to either your Social Security number, EIN number or both.
For the trade line to report solely on business credit, it must be attached to your business EIN, and not your Social Security number.
This will not work with S corporations, as the business and its liabilities are guaranteed by the individual owner.
There are pros and cons of forming any corporation — S-corps, LLC, C-corps — so check with your tax adviser before doing so.
How does business credit work for independent contractors?
Business credit is perfect for independent contractors. Independent contractors can obtain business credit established through their corporation and should consider business credit as a financial cushion for their business.
Independent contractors will also see more tax breaks and write-offs if they establish a corporation. These benefits are not offered to S-corps or sole proprietors because the individual is most often responsible for any business debt incurred.
You need to get your business to support itself and you — not you supporting your business.
Paul Oster FICO PRO is the CEO at Better Qualified, LLC. You can follow Paul on Twitter and LinkedIn.
