Contractor Kickstart! Part 2: Credit
Estimated Read Time: 8 minutes
12-19-2023
This is the second of six installments in the blog series “Contractor Kickstart!” in which the team at Jet Insurance intends to pass on helpful knowledge to aid in your venture to become a successful contractor. The other installments can be accessed from the blog home page or at the bottom of this article.
In the world of business, they say “Cash is king.” Although having cash is good, as a society, financial institutes need standardized ways to distinguish between those who manage their finances responsibly and those who do not. In this edition of “Contractor Kickstart!”, we’ll be diving into the world of individual credit and why it is essential as you are solidifying yourself in the journey of becoming a contractor.
The Essentials of Credit
The most important area of focus in your credit journey is your credit score. This score is attributed to you as an active user of credit, measuring your creditworthiness. This determination directly affects how banks and lenders perceive your credit-handling abilities. The higher the credit score, the more trustworthy you are in the eyes of financial institutions and other areas of business that utilize credit as a judgment factor (e.g. landlords and employers).
Before getting into the finer details, let’s define some key credit terms. Keep in mind this is not an exhaustive list of credit terms.
| TERM | DEFINITION |
|---|---|
| Credit Score / FICO Score | Credit score and FICO score are commonly used interchangeably. Many different types of credit scores exist, FICO score being just one of them. Ultimately, credit scores and a FICO score are both scores representing a person’s creditworthiness to lenders and financial institutions. Read more about FICO and credit scores in this Investopedia article. |
| Tradeline | A tradeline is an individual account listed on your credit report. From accounts like auto loans to credit cards, these count as individual tradelines that can be seen by anyone who pulls your credit inquiry report. |
| Credit History | Credit history outlines how you’ve managed your credit in the past, including any active tradelines, bankruptcies, or missed payments. How long you have had active credit lines affects your credit history—a longer amount of time with established credit is viewed as more reliable than newer credit. |
Credit Utilization | Credit utilization is how much credit you’ve used relative to how much total credit you have available. (e.g. you have a total credit limit of $1,000 and you’ve used $100, then you have used 10% of your total credit utilization.) |
Credit Check / Credit Inquiry | A credit check, otherwise known as a credit inquiry, is when you or an authorized party looks at your credit report. There are two main types of credit inquiries: soft inquiries and hard inquiries. Soft Inquiry: A soft inquiry happens during pre-approval when the application has not officially started yet. The lender/company wants to get an idea of where your credit stands to see what you may qualify for. Soft inquiries also occur when you check your credit score. A soft inquiry does not impact your credit score. Hard Inquiry: A hard inquiry happens when applying for a new, specific line of credit or loan (like a mortgage or car loan). Hard inquiries impact your credit score because each review/pull lowers your score by a few points. |
As mentioned earlier, you want to pay attention to your credit score because this is a major factor for most applications requiring any type of credit check. Your score is not arbitrary; it is made up of five major factors, which we break down below.
Because your credit score is made up of these different considerations, most places requiring a credit check will do so to assess your history of handling finances. One benefit of a credit check is if you’ve been responsible with your credit and finances over time, you would most likely be eligible for the lower rates on company necessities like insurance policies and bonds.
Alternatively, if someone has a low credit score due to late/missed payments on credit cards or loans, it is seen as a red flag, as this suggests the person may not repay borrowed money. This raises the risk for the lenders and companies, and as a result, they may require extra stipulations such as charging higher premiums or interest rates to compensate for the increased risk.
When it comes to construction bonds, an individual’s credit score plays a substantial role in overall cost. What the bond companies provide is essentially a line of credit you never want to use. If you have a low credit score, it signals to bond companies you may not pay back your debts on time, making it much riskier for them to give you money. Think about it—would you want to loan out thousands of dollars to someone who’s not known for paying people back on time? It’s important to note that should a bond claim happen and be paid out for you, you are liable to pay the surety company back for the full claim amount. Check out Jet’s surety bond guide for more information.
So now you might be thinking, “well…I don’t want to risk having a low credit score. What if I just don’t use credit at all?” While it’s your choice whether or not to be a user of credit, the truth is that it will affect pricing on business expenses such as insurance and surety bonds. Without credit, lenders and bond companies may ask for additional information such as previous financial statements to prove your ability to pay back debt. Still, having no credit score is better than having a bad credit score.
Aim to keep your credit score high and you should be in good standing with lenders to get the best rates on what you’ll need to get your contracting business started. If you don’t have any credit right now, one of the easiest ways to build your score is by opening up a secured credit card at your local financial institution. A secured credit card is different from a traditional credit card in that the secured card requires you to provide a cash deposit to open up the account.
Once you have some type of way to establish credit, here are some tips to follow to make sure you keep your score high:
- Always pay your credit card back on time. While you can make the minimum payments to avoid any late fees or penalties, aim to pay back your balance in full each month to keep your credit utilization low. 35% of your credit score depends on your on-time payments, so make sure this takes priority!
- Aim to have your total credit utilization percentage be 30% or lower. To do this, you should know what your credit limits are across all your different credit cards (if you have multiple) and aim to spend no more than 30% of the limit amount.
- The longer the history of credit you have, the better the chance of keeping a high credit score. This is with the exception you have a good credit history, of course. However, because how long you’ve had credit does matter, it does help to have your accounts open for as long as possible. Credit cards should be closed in rare circumstances. Even if you aren’t using the card, consider keeping the account open because closing a credit card to open a new one later on can negatively affect the credit age factor.
FAQs about Credit
What if I only deal in cash?
Speaking to those who prefer to pay for everything in cash, while there is nothing wrong with doing this, there are certain consequences to be aware of. As it is an industry standard for places like bond companies, lenders, and financial institutions to use a personal credit score as one of their risk evaluation tools, not having a credit score might mean you most likely will not qualify for the lowest rates possible. To easily remedy this, work to consistently have one active tradeline to establish some type of credit score and establish creditworthiness.
When it comes to your surety bonds specifically, not having a credit score is going to affect your premium pricing, but the severity of the impact is going to be different from company to company. In California, the alternative to purchasing a bond is to put up a $25,000 cashier’s check with the California State Licensing Board (CSLB). Keep in mind the $25,000 remains in the care of the CSLB. In the event of a claim payout, you are responsible for replenishing the account to its full limit.
I haven't used credit in years. How does this affect my premium on a bond?
Surety companies have rates for contractors who have not used credit in a while. Keep in mind not using credit for an extended period and not having a credit score are completely different scenarios. People who have not used credit in over six months or have opened up a very new account less than six months old will generate either a 9002 or 9003 credit score in place of a traditional credit score ranging from 300 to 850.
A 9002 score means there has been no activity on the credit report for the past six months. This can happen if you have no debt or loans to pay off and are not actively using credit cards to make purchases. A 9003 score means the credit accounts are younger than 6 months and indicate a lack of full history to generate a credit score, but there is a tradeline under your profile. Since these 9002/9003 credit scores fall outside of the normal credit score range, they have specific underwriting criteria to adhere to. The only way to know for sure what your premium is going to be is to get a bond quote for your specific needs.
My credit score is not great right now, so I’ve been getting high quotes everywhere I go. Will my premium for bonds always be this high?
No, if your credit score improves at the time of your bond renewal, surety companies will look at an updated credit activity and establish if you are eligible for lower premiums. As mentioned earlier, credit scores are refreshed roughly every 30 days. Let’s say you purchase a bond for a one-year term and you aggressively pay off debts for the next 12 months. Upon renewal, your premium may drop significantly as your credit score rises. Keep in mind if your initial bond premium is high due to low credit, many companies will not review credit on the bond every 30 days to see if your credit has improved, this will happen upon the annual renewal.
This brings us to the end of our credit portion of Contractor Kickstart! We hope this piece sheds some light on important credit topics and imparts some wisdom that will be helpful on your independent contracting journey.
In the next edition of Contractor Kickstart!, we’ll be talking about investing in tools that might make your day-to-day as a construction contractor easier and much more efficient.
Access other Contractor Kickstart! articles:
