SCHUFA and Business Credit Checks: how does it work?

The three biggest fears of most Ausländers, and frankly most Germans, are pretty easy to identify: Finanzamt, Ausländerbehörde and SCHUFA. For freelancers and the self-employed from abroad they are likely to have concerns about all three that intersect at different points in their lives and careers. Today, we are going to talk about SCHUFA, but some myths and hopefully explained an overly complex and sometimes unfair system of rating your worthiness - because yes, for freelancers and the self employed, it matters a lot! Almost no one, whether a private person or entrepreneur, can escape the ubiquity of SCHUFA and other credit agencies. In the case of running a business in particular, the rating of the credit bureaus may decide on success or failure, so founders, in particular, should familiarize themselves with the matter.

Now, we need to make a quick differentiation. We will talk first of all about freelancers, then a little more about the self-employed which would include people involved in partnerships, GmbH or similar business operations - because there are some key differences. Firstly, it should be noted there are some classic differences in how SCHUFA sees a natural person and a natural person who is also a freelancer or self-employed person. In Germany, your creditworthiness is recorded and stored by SCHUFA Holding AG, Germany's largest credit agency - by everyone who is registered in Germany.

The abbreviation SCHUFA stands for "Protection Association for General Loan Assurance". And whenever someone speaks of SCHUFA points, SCHUFA reports or SCHUFA ratings, he or she means the same thing: your creditworthiness. This is a measure of how reliably you are committed to making utility bills and credit card payments, and how high the likelihood that you will continue to dutifully perform.

When you also have a self employment situation, as a natural person, SCHUFA would look at you as an entrepreneur, whereby a search is carried out with the first and last name of the small business owner or freelancer in the SCHUFA personal database. The information contained in the information is supplemented with the B2B score for entrepreneurs. The information provided in the report is as follows:

1. Personal details (personal master data: surname, first name, current address, gender, date of birth, place of birth, identification number [SCHUFA-Perskey])
2. Information about the establishment of a business relationship and the contractual processing ("positive data")
3. Data on the non-contractual processing of transactions ("negative data")
4. Data from public directories and official notices ("public negative data")
5. SCHUFA FraudPool information *

Bear in mind, the average data SCHUFA saves on people:

1. Names
2. Date and place of birth, if applicable
3. address
4. any other addresses, including earlier addresses
5. Your personal SCHUFA base score

They are then provided information from their partner companies about:

• Bank accounts
• Credit cards
• Leasing contracts
• Telecommunication accounts
• Mail order accounts
• Installment transactions
• Loans and guarantees

How is the SCHUFA score determined?

The aim of the credit agency is to create a score for each person asked. SCHUFA tries to predict how high the probability is that a customer will meet their payment obligations - which is crucial for the seller or provider, for example in the case of installment payments, loans and purchases on target. The score is calculated using mathematical-statistical methods and is based on the stored information. Some credit agencies do not give a score, but make a recommendation in the form of a traffic light system.

The algorithm on which the score is based is of course secret. The fact is, however, that in addition to the credit history (including personal loans or mortgage lending), past consumer behavior is also included in the score. An example: the more credit cards or mobile phone contracts are used, the more detrimental it is for the personal rating, because excessive consumption is often the cause of personal bankruptcies. In general, the main causes of private over-indebtedness are unemployment, low wages and consumer behavior that does not match income. But you can also quickly get into financial difficulties through a failed self-employment or separation and divorce.

Capitalism never leaves you wanting for ways to end up broke and penniless! There are more personal bankruptcies in large cities and metropolitan areas than in rural areas. Many other attributes are secret, so for a long time, it was assumed that the place of residence and the associated demographics in this area also influence the score. However, this has been denied several times. Here is some of the information SCHUFA does not, and cannot have, despite a Facebook post that might tell you differently:

• Wealth and income
• Marketing data (buying behavior or the like)
• job
• Attitudes towards life and memberships (e.g. religious, political, etc.)
• marital status
• Nationality

When is the score requested?

Many companies have in their general terms and conditions that the customer must agree to a review by the credit bureaus. As a rule, the customer agrees without having read the terms and conditions carefully when ordering books, entertainment electronics or clothing via the Internet. In some cases, only the address provided is checked and the creditworthiness is not automatically determined. This "small" query is intended to reduce unnecessary returns in shipping to a minimum and prevent cases of fraud.

Many companies report their payment history, especially in the case of negative incidents, back to the respective credit agency. The customer can assume that they will no longer be able to order products or services on account for some time if his payment behavior was not optimal in the interests of the respective company.

Who can obtain information?

When collecting inquiries, the Federal Data Protection Act assumes a “legitimate interest”. This basically exists when a trader takes a business risk within a business relationship. This is the case when traders find out about other companies or private individuals with whom a business relationship is to be initiated or already exists. The situation is different with private individuals who want to obtain information about other private individuals, here only landlords (not commercial) are allowed to check potential tenants with the services of a credit reporting agency.

The "queried" is not informed of the query. Before a bank grants a loan, it must check how high the equity cover is, as there are guidelines on how much the loan applicant must bring. There are two ways of doing this, one of which is internally based on the bank's experience with the customer, and the other invoicing. Depending on how the default risk is assessed, the interest rate increases or decreases accordingly.

Completely independent of possible start-up projects, every citizen should therefore have an original interest in the best possible score; in addition to credit decisions, other projects such as new credit cards, mobile phone contracts or leasing are significantly simplified.

Why the score is important for founders

For founders, even more depends on a good score. Even when founding a corporation, the founder is in many cases, at least initially as a private person, liable for any external financing. One of the greatest challenges for founders is to find a bank to finance their own project. If the credit decision-makers at the bank are convinced of the project, a self-assessment of the shareholders must be drawn up and the assets contained therein must be documented accordingly.

Even if there is a guarantee, for example from a guarantee bank, the personal creditworthiness is checked. In the case of leasing or other financing projects, the shareholders or the newly founded company also carry out a credit check.

A further complicating factor is that the data from the credit reporting agencies are not always up-to-date. In the “Consumer Information Scoring” of the Federal Ministry of Food, Agriculture and Consumer Protection from 2009, reference is made to a study in which only 12% of the respondents in a representative population survey in 2007 knew the term “scoring”.

On behalf of the Federal Ministry, a research group of 100 test persons from all over Germany requested a self-assessment from three credit agencies: SCHUFA, Creditreform and Arvato. In the study, 45% of the information provided by SCHUFA had incorrect, incomplete or incorrect entries.

Creditworthiness criteria

When assessing the creditworthiness of a company, balance sheet ratios play a major role. In addition to the annual financial statements, the equity ratio, the available cash reserves as well as the free and operative cash flow and of course the profit or loss development are of interest to the auditor. The quality of management as well as investment projects or the current asset and debt situation also play an important role.

Credit rating for companies

In practice, the creditworthiness of a company is measured in scores or ratings. This rating can fluctuate between “very good creditworthiness” and “justifiable creditworthiness” and is usually determined by rating agencies. Creditworthiness is given if the company or the debtor receives a rating that is within the scope of "investment grade".

Effects of credit rating

Of course, it is advisable to carefully check the business conditions for companies with poor credit ratings. Overall, the aim of the credit rating is to determine the debtor's credit risk by means of a rating. For the company concerned, a deterioration in creditworthiness often results in higher refinancing costs, since the loan interest includes a creditworthiness-dependent risk premium. If a company has a good credit rating, the loan rate is usually lower than if it has a bad credit rating. Conversely, companies with poor credit ratings pay higher interest rates.

OK, what if you messed up? How long will it take to clear the debt?

​​Ironically, the entries on repayment difficulties for loans or insolvency - i.e. those that cause the greatest difficulties with a new loan application - stay in your SCHUFA information the longest. Once you have paid the claim, it will take three years for the entry to be deleted. And the counting of these three years does not start until the end of the year in which you paid off the debt. For example, if you pay an overdue amount in the spring of 2019, the waiting period for deletion does not begin until the turn of the year 2019/20. Three years later, on January 1, 2023, you will then be rid of the entry.

After all: If the creditors report the payment to the SCHUFA, the entry remains. But he already gets a “completion note”. This means that the SCHUFA still remembers that you were once in arrears with a payment. But she also registers that the case is now ticked. Accordingly, your SCHUFA score should rise a little again. Kind of seems unfair if you pay the debt entirely, but O.K.!

Hopefully, you are able to better understand how this impacts your life in this context. It is very different from the way credit works in other countries - the subtle nuances and similar. It is also a myth that having a company or corporation gets you out of having no access to loans and financing - there will always be some elements of private discovery. There’s already a lot to think about when starting a business, outside of actually doing it so best to be informed!  As a freelancer and self-employed person, maybe you do not need access to credit, but no matter your situation it’s important to know how the system works!