If you’re seeking working capital for your business, less-than-perfect credit can make finding a loan hard.

Most banks and credit unions lenders prefer borrowers with good or excellent credit. But with an online lender, you’ll generally have more flexibility. Still, if you have poor credit — or a personal FICO score between 300 and 629 — you’ll be viewed as more of a credit risk and charged a much higher interest rate, asked to put up collateral or denied financing altogether.

Fortunately, there are bad credit business loans designed to help credit-challenged borrowers access funding, minus the red tape. But before applying, it’s worth considering the benefits and drawbacks.

What is a bad credit business loan?

As the name suggests, a bad credit business loan is a financing product that caters to business owners with less-than-perfect credit. They’re more commonly offered by online lenders.

They work like any other business loan. You’ll apply directly with the lender and submit any required documents. But this loan comes with steeper borrowing costs to protect the lender if you default on the loan agreement. 

Term loans and lines of credit are common funding options. However, certain business loan types are often more easily accessible to borrowers with bad credit. These include merchant cash advances that let you borrow against future debit and credit card sales, plus invoice financing or factoring, which allow you to trade unpaid invoices for cash.

Bad credit business loan pros

These loan products have advantages that could make them the right funding source for your business.

Fast approvals and funding times

You can generally apply for a bad credit business loan and receive a lending decision as soon as the same day, or even faster.

And depending on how soon you can upload or send over the required documentation for final loan approval, the loan could be funded as quickly as the same day or within a few business days. 

Rebuild credit  

Many lenders report payment history to at least one of the three major business credit bureaus — Experian, TransUnion and Equifax.

 Payment history is the most significant component of your credit score, so making timely payments on your business loans could help build your business credit score, assuming you responsibly manage all other outstanding debt obligations. A higher credit score puts you in a position to qualify for more competitive loan offers in the future. 

However, not all lenders report payments to credit bureaus. Check first before committing to a loan.

More affordable than credit card debt

You can expect a higher interest rate with a bad credit business loan. 

Still, the rate you receive is likely much lower than what credit card issuers offer to business owners with lower credit scores. Plus, you’ll get a set repayment period that limits the interest you pay over time. This isn’t the case with business credit cards, as only paying the minimum means you could spend several years paying interest until the balance is paid off. 

Bad credit business loan cons

Despite their attractive benefits, bad credit business loans also have their share of drawbacks to be aware of when evaluating your funding options. 

Lower loan limits 

Some lenders offering bad credit business loans offer maximum loan amounts than you’d find with traditional business loans. 

If you have significant funding needs, you may have to take out several loans or resort to an alternative funding source if the lender doesn’t offer the loan amount you need. Or you could hold off on applying for a loan and work to improve your credit score to unlock better funding opportunities. 

Higher interest rates and fees 

A lower credit score means your funding options are likely limited. Lenders know this.

Unfortunately, this usually means higher interest rates and fees for the borrower as the lender tries to offset the risk you pose. Shop with multiple lenders before applying to find the option that offers the most favorable terms and helps you minimize borrowing costs. 

Collateral requirements 

You may find that lenders aren’t willing to lend to you unless you put up collateral. A secured loan may seem appealing, especially if the terms are competitive. The downside is that you could lose your asset if you fall behind on the loan payments.

If you’re confident making loan payments won’t be an issue, go with a secured loan. Otherwise, consider unsecured loan options, even if it means slightly higher borrowing costs, to protect your business assets.

Alternatives to bad credit business loans

If a bad credit business loan is a bad fit for you, consider these alternatives: 

  • Check with online lenders. Their eligibility guidelines tend to be more lenient. You could get approved for a loan with a lower credit score even if you’re a startup. 
  • Work to improve your credit score. If your application was denied, contact the lender to learn why. Also, get a copy of your credit report, identify areas that need improvement and devise a plan of action to boost your credit health so you’ll have better approval odds the next time you apply for funding. 
  • Borrow from a friend or relative. You can take out an interest-free or low-interest loan from a friend or relative. Be sure to only borrow what you can comfortably afford to pay back and get the loan agreement in writing. 
  • Use a personal loan. A personal loan may be an option if you’re planning to open a business soon. Some lenders restrict the ways funds can be used, so confirm business expenses are allowed before moving forward.
  • Use a crowdfunding platform. Consider raising funds for your business through a crowdfunding platform like Indiegogo or Kickstarter. You’ll generally have to provide equity in your business or something of value in exchange for donations. Still, you won’t have to pay the money back to donors. 

The bottom line

Ideally, you want a small business loan that offers competitive terms and meets your funding needs. If you have bad credit, your options may be limited, but that doesn’t mean you’re entirely out of luck. 

A bad credit business loan could be a solution, but it’s worth evaluating the benefits and drawbacks to decide if it’s a good fit. 

Familiarize yourself with the small business lending process and shop around with multiple lenders to find the best deal on financing. Most importantly, run the numbers to determine if you should move forward with applying or explore an alternative funding source.