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The Rules Are Changing On Small Business Debt Recording To The Credit Bureaus

Small business debt hasn’t traditionally been reported to consumer credit bureaus, but the rules of the game are changing

The third sentence in the letter a client received earlier this month about his $50,000 loan from Capital One (COF) surprised him: “We’ll begin reporting your loan status to business and consumer credit bureaus from August 1, 2009.” In more than 20 years as an entrepreneur, our client states that business loans had never affected his personal credit score.

Small business borrowing is generally not reported on owners’ consumer credit reports unless they fail to pay on time.  With banks facing rising defaults, at least one lender is moving to add small business loans to borrowers’ consumer credit files, which means that small business owners could soon find that their business debts affecting their personal credit. Any debt that owners personally guarantee—including many business loans and credit cards—could be reported.

Our client took out the Small Business Administration-guaranteed loan through Capital One in 2006 to buy restaurant equipment for his restaurant in San Francisco CA. He personally guaranteed the loan—as the SBA requires—and owes about $25,000 remaining. Although he has never missed a payment and his credit score, is 760,  he worries that his credit will suffer when the business debt suddenly appears on his consumer credit file. He’s also disturbed by the precedent: “I signed on [for] a business loan with my LLC. Now three years later you want to make it a personal note?” he says.

Are Deliquencies to Blame?

Small business borrowers at Capital One’s local branches already have their business loans reported to consumer credit bureaus,  and the bank will soon report online and direct mail business customers as well.

Capital One began reporting small business loans to one business credit bureau, the Small Business Financial Exchange, in 2007 and is extending the policy to other business and consumer bureaus. “This is standard industry practice,” our client was told. “Full and accurate reporting is best for the consumer, the business, and the system as a whole.”

Capital One declined to detail the reasons behind the change or how many borrowers would be affected. One clue may lie in the bank’s growing number of delinquencies—a problem not unique to Capital One, as financial stress causes rising defaults across the economy. In its most recent quarterly report, Capital One noted “a more rapid degradation in our installment loan businesses” that caused higher charge-offs in the business unit that holds these types of loans.

That division’s net income dropped to just $2.4 million in the first quarter, down from $491 million in the first quarter of 2008. The unit also includes Capital One’s U.S. credit card business and other consumer loans, so it’s unclear how small business loans alone are performing, but the segment’s net charge-off rate for the first quarter was 8.39%, up from 5.85% a year earlier, according to the filing.

Capital One recorded its first annual loss in 2008, with a net loss of $46 million, compared to net income of $1.57 billion for 2007.

Would reminding business borrowers that their personal credit is on the line help Capital One reduce defaults? Any non-payment on a personally guaranteed business debt would show up on the owner’s consumer credit report anyway, regardless of whether the lender reports the account as a matter of course

Credit Score Concerns

Credit experts say lenders don’t usually report business loans to consumer credit bureaus unless the borrower falls behind. “It used to be nonexistent,” says John S. a former Dun & Bradstreet Manager who is writing a book on the subject, “In recent years some banks have begun reporting [business credit]. It’s still a fairly rare occurrence for them to report to the bureaus.”

Because of the complexity behind credit scoring, it’s hard to predict how the shift will affect any one borrower’s credit score. Our client figures that his FICO score could drop 20 to 60 points when the loan’s $25,000 balance gets reported, because the credit rating weighs total debt and the amount of available credit being used.

John S. says business owners generally won’t see their credit hurt if they’re current on payments. Borrowers with strong repayment histories could even see scores improve, says John S. Our client doesn’t plan to find out. “I’m going to scramble and pay this off,” he says.

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