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Proving your worth: New credit rules for entrepreneurs

Plastic may be self-employed's lifeline, but it's not easy to get anymore

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Proving your worth: New credit card rules for entrepreneurs

It's getting tougher to fund the American dream of self employment.

Not so long ago, small business owners and sole proprietors looked to short-term loans to "fill in the gaps" between cash flow ebbs and tides. But those loans are no longer an option in this recession, and entreprenuers are turning to credit cards.

According to a June 25 report from the Federal Reserve, credit extended to businesses shrunk by a little more than 18 percent in April 2009. And almost four out of 19 entrepreneurs say they can't get the financing they need to keep their businesses up and running, according to a May 2009 study from the National Small Business Administration.

The NSBA study that 59 percent of small business owners reported using credit cards to finance their businesses, up from 49 percent in December 2008. 

Scott Stevenson, an attorney and consumer rights advocate in Atlanta, has a cautionary tale for self-employed consumers eyeing a new credit card, or perhaps a hike in their limit. "You may be facing an unexpected series of roadblocks in the path to obtaining credit." A whopping 75 percent of small business owners reporting that their credit card terms have worsened in the past six months, reports the NSBA.

The rules have changed
The Credit CARD Act of 2009 has issuers -- who are already tightening up courtesy of the credit crunch -- imposing stricter application procedures and tougher approval guidelines than ever before. One roadblock for the self-employed, says Tom Dailey, Chicago-based card industry consultant and former senior executive at Discover Card, is "self-employed applicants now need to show proof of earnings for the past two consecutive years (among other things), in addition to having a nearly stellar credit score."

Have your terms changed?

Seventy-nine percent of small business owners reported worsening credit card terms -- up from 69 percent in December 2008.

 

In the wake of this new credit process, scores of small business owners and sole proprietors are scrambling to qualify for much needed credit cards -- especially ones with interest rates they can afford. "My credit score is in the upper 700s, and I have a good payment history, but I was recently turned down for a new credit card," says JuliAnne Taylor, 36, a freelance graphic artist in Seattle. Taylor's denial stems straight from her paycheck. "I don't have pay stubs, so I was told I needed an accountant to verify my income." A tough feat since Taylor doesn't have an accountant. "I felt trapped in a vicious circle," she adds.

Assessing the approval process
Some issuers say little has changed in the approval process. "Generally, we look at credit scores, stability, ability and willingness to pay," says Bank of America spokeswoman Betty Riess.

But, experts caution getting an approval can now require applicants to jump through a series of hoops because the recession plus the new Credit CARD Act of 2009 has issuers cinching their belts tighter than ever before.

Business cards are exempt from the law; card issuers remain free to raise rates at will on them. But Stevenson says another section of the new law (which goes fully into effect in February 2010) in particular will contribute to the angst felt by self-employed applicants. "It amends the Truth in Lending Act, adding language requiring additional scrutiny for credit card issuers to look at an applicant's ability to make required payments before opening a new line of credit or increasing an existing one." And that could explain why some seeking plastic are having a tougher time reaching their goal.

Dailey adds one aspect of the law aimed at protecting cardholders limits a credit card issuer's (and a financial institution's) ability to raise interest rates and charge fees. This, and other aspects of the new law, have issuers taking fewer credit risks because they're no longer able to afford to absorb the costs of the risk anymore. "And being self-employed is seen as a risk," Dailey says.

Nailing down your numbers
before applying for a credit card

Experts suggest a proactive approach when applying for a credit card. "Knowing where potential snags might be will increase your chances of getting approved, and even speed up the approval process," says Tom Dailey, a Chicago-based card industry consultant and former senior executive at Discover Card. One of the biggest potential approval snafus is inaccurately reported income.

"Overstating your income can be just as detrimental as not having enough income," says Dailey.

A suspiciously high income or one that won't match your tax returns, will raise red flags and bounce your application into the denial pile.

On the flip side, too many tax shelters can backfire if you're looking to open a credit card. "This is something that goes against traditional logic when dealing with the IRS, since most who are self-employed look to shield as much income as possible," says Dailey. But lowering taxable income too much can work against you're in search of credit. Card issuers like to see income.

Bottom line: Give an actual representation of your income. "That will be one of the key things an issuer considers to extend you credit," says Dailey. 

Catching the green light
There are a few steps hopeful self-employed applicants can take before applying for a new credit card, experts suggest. Dailey and Stevenson agree that establishing a relationship with a card issuer is very beneficial for small business owners and self-employed applicants. Dailey says opening a bank account, preferably a savings account, "shows your commitment to the business relationship."

If you already have an existing banking relationship with an institution, that's the first place to submit a credit application. "Banks and credit unions often will consider the total value of a business relationship, which can improve your chances of being approved for a credit card," says Dailey.

Stevenson advises gathering the same documents you'd need to apply for a normal business loan before submitting an application. "Chances are, you'll need some, if not all, of them. Having them on hand can speed up the process," he says. Not having that on hand may result in a high interest rate, paltry credit limit, or worse -- not having credit extended at all.

Here are the items you'll need:

  • Financial statements. Compile one to three years of tax returns, profit-and-loss statements, balance sheets and bank statements. Another option is a signed affidavit of correctness of the data on the application and confirming personal responsibility for the account. These will provide a potential issuer a snapshot of your financial activity and illustrate your potential credit risk.
  • Itemization of collateral, including real estate, vehicles and other property.
  • Your business plan. Having a well-developed business plan will demonstrate you've given thought to many of the issues facing your business and how you intend to succeed.

If you are declined for a credit card, don't despair. Dailey says ask the issuer if it would be willing to consider a lower credit line or higher interest rate. "Sometimes, you can negotiate your way to a new account."

See related: A comprehensive guide to the Credit CARD Act of 2009, National banks tightening credit card lending standards, Used wisely, small business cards can keep business afloat, Small business credit card comparison chart

Published: July 27, 2009


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