credit

Your credit score, that magical, mysterious three-figure number that dictates who will lend to you and on what terms, can make the difference between success and failure for your business.

Carl Faulds, Managing Director at Casholv, looks at how your score is compiled.

The FICO algorithm that forms the basis of your credit score (though, confusingly, each credit bureau interprets it slightly differently) focuses on several different factors. Your payment history makes up 35% of your score; the amounts you currently owe comprise 30%; the length of your borrowing history represents 15%; your mix of credit (particularly focusing on riskier forms of borrowing such as credit cards, lines of credit and overdrafts) contributes 10%; and your recent credit applications make up the final 10%.

So how exactly does the last factor come into play?

All about applications for credit

Whenever you apply for credit (of whatever type), the lender will almost certainly run a credit check with one or more of the bureaux. An enquiry can be either hard or soft, and this can make a huge difference to the way it affects your score.

A soft credit enquiry is one where your history is not being reviewed in order to decide on a potential loan. This means that if you decide to check your score periodically, which is a very good idea, as mistakes can sometimes creep in, it will be regarded as a soft enquiry and will not compromise your rating. Soft enquiries can also come from potential suppliers or from lenders who wish to see whether you prequalify for a particular product, ensuring they do not waste time processing a fruitless application.

In contrast, hard enquiries come at the decision-making stage: the result will dictate whether or not you are offered the loan, line of credit or business credit card you applied for. These enquiries almost always come from banks and other financial institutions and are more likely to affect your score – even if you’re ultimately turned down. That said, hard enquiries quickly age off, ceasing to affect your credit score after six to 12 months and remain on your credit report for only two years.

So why do hard credit enquiries affect your score?

FICO’s extensive experience of calculating credit scores demonstrates that companies that suddenly apply for a flurry of loans, overdrafts and cards are usually in trouble and are desperately trying to stave off disaster. The additional risk is further heightened if the business in question does not have a long credit history.

That said, one or two hard credit enquiries aren’t going to make any significant difference to your score. At the same time, FICO’s algorithm is intelligent enough to recognise the difference between a company shopping around to make sure it gets the best deal and a cash-strapped business on the edge.

For this reason, if you apply for the same type of credit account from multiple lenders within a 30-day window, it will be treated as a single hard credit enquiry. In contrast, if you start looking for a bank loan, overdraft, line of credit, business credit card and merchant cash advance simultaneously, this would be considered a huge red flag.

Finally, it’s possible that a hard credit enquiry you didn’t make might end up on your credit report. That’s another reason you should regularly check your report – a soft enquiry – and quickly address any errors that you spot.

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