If you have a great idea for a business but don't have the funds to start it up, a small business loan is a great option. Last year, the average small business loan was $375,000. While small business loans are a great low-cost option, you must have excellent credit to get approved.

Like any type of loans, a good credit score will get you the best interest rates. In some cases, your credit might be so bad that you don't even get approved for a loan. If you have bad credit, you'll want to work on building your credit back up before applying for a new loan.

Read more to learn how to build your credit up and increase your credit score.

How Is Your Credit Score Calculated?

Your credit score is calculated based on the information on your credit report.

The most important factor that impacts your score is your payment history. If you always pay your bills on time, you have nothing to worry about. But, if you have a history of late payments, particularly more than 30 days late, your score will suffer.

The next most important piece of information is how much debt you have compared to how much you have available. This is your utilization ratio and experts say its best to not spend more than 30% of your available credit. If you have $100,000 in available credit, you shouldn't have more than $30,000 in debt to abide by this rule.

Your credit score also considers how long your credit history is. People with longer credit histories generally have better scores. If you have a lot of new accounts or inquiries into your credit, your score might be lower, as well.

Lenders don't want to see a bunch of new accounts opened recently. They're also interested in what kinds of accounts you have. It's better to have a mix of accounts, like a mortgage, car payment, student loans, and credit cards, rather than just credit cards.

Overall, lenders want to see that you can use your accounts responsibly. If you haven't been using them responsibly, you might find yourself with a bad credit score.

Banks often turn away 80% of small business loan application because of their strict requirements, so having a great credit score is necessary.

What Is Bad Credit?

There are two main companies that calculate your credit score. The most common, calculated by the Fair Isaac Corporation (called your FICO score) ranges from a low of 300 to a high of 850.

FICO doesn't actually rate your credit; it just provides the score and your lender will decide whether that score is good enough or not. In general, though, most lenders follow these guidelines:

  • 750-850: excellent credit
  • 700-749: good credit
  • 650-800: fair credit
  • 300-649: bad credit

To get the best interest rates and make sure you're approved for loans, you should shoot for the highest score possible. If you check your score and find yourself in the fair or bad category, you can start improving your score right away.

If you're planning to apply for a business loan in the near future, you should start immediately trying to boost your score.

8 Tips for Building Your Credit

Building your credit takes time and it won't happen overnight. If you have years of bad credit and a low score, you need to be patient and realize that there's no quick fix to improving your credit.

But, you should continue working to improve your score. Here are eight ways to do that.

1. Assess Your Score and Credit Report Accuracy

The first thing you should do is pull your credit reports. You can get a free one each year from each of the three main credit bureaus.

Review your report to make sure everything is accurate. If there are any mistakes, address those with the credit bureaus.

You should also get your credit score too. It's not included on your credit report but many lenders and credit card companies will provide you with your score for free. Once you have your credit report and your score, it's time to make a plan to pay down your debt and increase your credit.

2. Keep An Eye on Your Balances

Since the recommendation is to keep your balance to 30% of your available credit or less, watch your balances to make sure they aren't going over this amount.

If they already are, you'll want to focus on tip number 3 below.

3. Eliminate Credit Card Balances

Pay down your balances as much as possible. You can use a debt snowball method, where you pay off the smallest balance first and then once that's paid off, use that payment to start working towards the next biggest balance.

Whatever method you choose, lowering your debt and credit utilization is effective at boosting your score.

4. Don't Close Old Accounts

You might think that closing old accounts that aren't being used will help your score, but it's actually counterproductive.

By closing old accounts, you're reducing your available credit, which increases your credit utilization and also shortens the length of your credit history.

In simple terms, leave those old accounts open.

5. Automate Payments

Automating your payments will help ensure your bills are paid every month and on time. This won't cost you anything and will take the pressure off of you to remember to pay your bill every month.

6. Pick Up a Side Hustle

A side hustle to bring in more income is a great way to pay down your debts. Put all of your extra money towards your debts and see those balances go down faster.

7. Bring Any Delinquent Accounts Current

If you have any old accounts that are delinquent or in collections, make them current. Pay what you owe to get them out of delinquent status and then make sure you continue to pay them on time.

8. Don't Apply for New Credit

Lenders don't want to see a bunch of new credit inquiries or large purchases in the few months leading up to applying for a loan. Don't apply for new credit or spend large amounts of money on your credit cards if you're planning to apply for a business loan soon.

The Bottom Line

Although it will take time, building your credit back up after it takes a nosedive isn't impossible.

Use the tips listed here and start working on this right away. With a little patience and dedication, you can increase your credit and improve your chances of getting a loan.

Check out our site for great small business loans and other resources for funding your ideas.