You may already be familiar with personal credit, but did you know businesses can have credit too? Understanding the differences between personal credit and business credit is desirable if you are an entrepreneur, small business owner, or are just concerned about your personal finances and need to pay down business expenses or personal expenses. In this article, we will walk through both personal credit and business credit so you can understand the differences between the two.
Your personal credit is your creditworthiness as an individual. Unlike a business credit, personal credit connects to your Social Security Number. You can build personal credit by properly handling your finances and loans. In this next section, we will analyze personal credit and what makes it unique.
What is Personal Credit?
As stated before, personal credit is your creditworthiness. Personal credit assesses your ability to pay back credit accounts, as compiled in your credit history. Improving personal credit can improve your credit score, which allows you to get a better loan rate. Several different credit bureaus report on personal credit. These credit bureaus use your credit to create a score between 350-800, with 350 being very low and 800 being a so-called perfect score. This score is compiled in a FICO score, which credit issuers will always check before approving or denying you for a new line of credit.
What is Personal Credit Used for?
Personal credit is associated with credit cards. However, personal credit can be more than just credit cards. Personal credit is also used for determining whether you will be approved for new credit and the rate associated with your credit. Personal credit is usually used for personal purchases, but available credit can also be key when you purchase a home. Today, the cost of living in both the US and Canada has increased dramatically. For example, starter homes can cost upwards of $500,000, so understanding personal credit can be vital to securing a mortgage.
Surprisingly, personal credit is also used for overdraft protection. One way banks provide overdraft protection is by extending you a personal line of credit, usually for around $1,000. If you overdraft your account, the credit line will cover the balance. This is why it is vital to pay down your line of credit to reduce credit risk and avoid late payments–otherwise, you may find yourself using too much of your credit, which can hurt your credit score.
What Types of Personal Credit Are There?
1. Revolving Credit
A line of credit is a type of revolving credit. Revolving credit is a type of credit that allows you to spend until you reach the limit. Usually, there is no fixed repayment schedule, and you simply pay it down before using it again.
A personal credit card is also a type of revolving credit, but usually, these come with a monthly minimum payment requirement.
2. Open Credit
Open credit is a type of credit that requires a full payment every period, usually monthly. Like, revolving credit, you can borrow up to the maximum amount, but you have to repay the funds at the end of the month. Cell phone bills, for example, are usually open credit.
3. Installment Credit
Finally, personal credit usually features installment credit. Installment credit is most often associated with personal loans. With a personal loan, you receive one lump sum and then pay it back over time, with interest. Installment credit accounts can also be mortgages, car loans, personal loans, and even student loans.
How Do You Build Personal Credit?
Building personal credit is not as complicated as you might think. If you have struggled in the past with building credit, there are a few simple steps you can take to build better credit.
First, building personal credit means you will need to open a credit account.
Today, credit unions and banks make this easy, by offering introductory credit cards to most new members. These cards will usually have a low balance limit and are great for building credit.
If you live alone, you likely already have a credit account (and thus a credit history) with your utility company. Utility bills are a type of open credit account. To protect your credit, make sure you pay your bills on time. Building credit requires time and patience by paying your bills regularly and on time, you can help improve your credit score.
Applying for a personal loan is another way to build credit. Remember, every time you apply for new credit, it can lower your credit score. If you desire to improve your credit score, then you should carefully balance new credit applications with your existing credit lines.
Opening a credit card can also help you build credit. Avoid hurting your credit score and in regards to credit utilization, keep your balance below 10% of your credit limit. This has a major impact on your personal credit history and thus your personal credit report.
Just like individuals have credit scores, businesses also have credit scores. However, there are some significant differences between business credit and personal credit. For example, unlike a personal credit score, business credit scores can be viewed by anyone. In this next section, we will discuss business credit and how it differs from personal credit.
What is Business Credit?
Even if you are already a business owner, you might not know what business credit is. Simply put, business credit is a business’s ability to buy something now and then pay it off later, just like when you take out a small business loan. Building your business’s credit is important because it can have a significant impact on your ability to be successful: a better business credit score can make it simpler to borrow money, and less expensive in the long run.
As we mentioned before, there are some important differences between business credit and personal credit. Business credit exists independent of personal credit, and as such, it also works a bit differently. For example, as explained earlier, there is no right to privacy for your business credit report, this makes it even more critical to understand business credit.
Business credit is acquired when your business first has a credit file created for it. Then, once a business credit file is created with a commercial credit reporter, others can buy that report and review it. This way, future lenders can reflect on your companyâs reputation and determine if you qualify for loans and other types of credit. Ultimately, business credit is a reflection of your business’s ability to pay back loans, and ability to acquire new loans.
Why is Business Credit Used?
Business credit is used for many things, but at its most basic, it reflects your business’s creditworthiness. However, business credit is used to qualify your business for different types of business credit accounts. These credit accounts are important because many companies and small businesses rely on them.
For example, just as you might have a personal credit line with your bank, an LLC or partnership can also have a credit line. Credit lines are instruments for organizations because you may need to charge money to your credit line while you wait for invoices to be received from your customers monthly. It can be hard to get a business loan in 2022, without good business credit.
The usefulness of business credit does not stop there. Business credit impacts other areas too.
Vendors may use your business credit score to determine if you qualify for a credit line with them. Insurance companies will also review your business credit if you apply for a policy; it can additionally affect your premium! Since your business credit score is available to anyone, other businesses might review your business credit before working with your company. As you can see, there are numerous different ways your business credit can impact your company or business.
What Types of Business Credit Are There?
Just like personal credit, there are many different types of business credit. Here, we will examine the three main types of business credit. If you have a company or are thinking of starting one, these types of credit are available.
1. Revolving Credit Accounts
Revolving credit accounts work similarly to personal revolving credit accounts. These are usually small business credit cards and lines of credit. Like personal credit, you will receive a preset credit limit. If you use up all the credit, you will have to pay it down before you can use it again. The good news is that revolving accounts for businesses tend to have higher caps than personal credit revolving accounts.
2. Installment Credit Accounts
Installment credit accounts work similarly to personal loans, but these are commercial agreements used for business loans. The terms of your commercial loan will vary depending on the lender, but you can expect to receive a lump sum upfront, and then you will have to pay it back over time with interest.
3. Vendor Credit Accounts
Vendor credit accounts are one of the more popular types of credit accounts for businesses. Recognize that companies often transact at higher volumes than consumers do. Because of this, commercial transactions usually have different conventions, with many companies offering their lines of credit to other businesses. Preferably than paying a paper company every time your office purchases printer paper, you can instead take out a vendor credit account and make a single payment monthly.
Sometimes these accounts are called net-30 accounts, which means you have 30 days to repay the credit line. However, other periods exist such as net-60, net-90, or even net-180. These vendor accounts can help your company manage its cash flow and build relationships with your suppliers.
How Do You Build Business Credit?
If you are new to building business credit, it can be frustrating to learn how it works. Before building business credit you will need to establish your company. One of the most significant considerations is forming a separate legal entity for your company. You can incorporate an LLC or corporation. Usually, you can do this by registering with the Secretary of State in the jurisdiction that you are located in (some states require you to register with the Department of Commerce, so make sure you check your local regulations).
After your business is incorporated, you can request an Employer Identification Number or EIN from the IRS. An EIN is necessary because you use this to personally identify your company when applying for a commercial bank account, loans, and paying taxes. Think of your EIN as the Social Security Number for your company. You can apply for your companyâs EIN online.
Finally, once you have an EIN you can open commercial bank accounts and begin acquiring business credit. A business bank account is essential because it will help make you more credible to lenders, ease your tax worries, avoid accounting problems, and keep your personal and business finances separate. Once you have a commercial bank account, you can begin applying for things like a business credit card and lines of credit. Over time, and with responsible spending, you will build your business credit.
The Bottom Line
Personal credit and business credit share many similarities, but they are used for very different things. However, both types of credit are key to your financial success. Understanding the differences between these two types of credit is a cornerstone of your financial well-being.