Do you need funding for your small business? Whether to cover a cash flow gap or expand operations, you’re likely considering a loan to meet your capital needs.
Both personal and business loans are an option, but how do you decide which is best? And should you use one over the other to fund your small business? Here’s a breakdown of how each works, how they differ and how to choose the most ideal option for your company.
What are Personal Loans?
A personal loan is a fixed-rate debt product that’s payable in equal monthly installments. Loan proceeds are dispersed in a lump sum, and you’re free to use the funds however you see fit. Many individuals consolidate high-interest debt, make costly home repairs or improvements, cover unexpected financial emergencies, or pay for major events like weddings, funerals, and other celebrations. Some also use the funds to start a business.
Most traditional banks, credit unions and online lenders offer personal loans. You’ll generally qualify for the most competitive interest rates if you have good or excellent credit. However, some online lenders offer reasonable rates to borrowers with lower credit scores.
What are Business Loans?
A business loan works like a personal loan but caters to small business owners. Furthermore, the funds should be used to cover operating expenses, fill cash flow gaps and foster expansion.
These debt products are also available through banks, credit unions and online lenders. In addition, you can also apply for a small business loan through the U.S. Small Business Administration (SBA).
Personal vs. Business Loans at a Glance
When deciding which option is best, it’s worth considering the qualification criteria and eligibility guidelines, along with the loan amounts, loan terms and interest rates. You also want to keep any other borrowing costs in mind to make an informed decision.
Qualification and Eligibility
Personal loans are generally easier to qualify for, especially if you’re just starting your venture. Your personal credit score plays a major role in determining your eligibility for a personal loan.
On the other hand, business loans require a strong business credit history and an established business entity. Personal loans can be used for business purposes, but business loans are specifically designed for business expenses.
Loan Amount
Business loans typically offer higher capital, which helps cover larger business expenses. Personal loans usually have lower limits, making them suitable for small-scale funding needs.
Interest Rates and APR
Interest rates and annual percentage rates (APR) for business loans tend to be lower compared to personal loans, as they’re based on the risk associated with the business. (Note: The latter includes the cost of interest and any applicable fees). Personal loans often come with higher interest rates, resulting in higher costs over the life of the loan.
Loan Terms
Business loans generally have more flexible repayment periods and can be structured to suit the needs of the business. Personal loans often come with fixed repayment periods and may have prepayment penalties if you repay the loan early.
Associated Costs
Both personal and business loans have other borrowing costs, such as origination fees and late payment fees. However, business loans may also have additional fees tied to the specific loan type, like SBA guarantee fees or costs related to the valuation of collateral.
Collateral
Collateral is an asset that can be used to secure a loan. Business loans often require collateral, such as business assets, inventory or property, to reduce the lender’s risk. On the other hand, personal loans are usually unsecured, meaning they don’t require collateral. Still, they may have higher interest rates to compensate for the increased risk.
Can You Use a Personal Loan for Your Business?
Yes. However, a business loan may be a better option. Here’s how to choose between the two options.
When It Makes Sense to Use a Personal Loan for Your Business
It could be more sensible to take out a personal loan for your business in these circumstances:
- You need a higher loan amount than a lender is willing to approve you for with a business loan. Personal loans often have higher maximum loan amounts available compared to business loans from traditional lenders. If you need funds for large capital expenditures or expansion plans, a personal loan may allow you to access the funding you require.
- You don’t have a written business plan. Some lenders may request it, including financial statements, bank statements and tax returns. Getting approved for a business loan can be challenging if you don’t have this information handy. A personal loan may be easier to qualify for without this level of business financial reporting.
- You prefer a loan that doesn’t require collateral (assuming a secured business loan is your only option). Many small business loans, especially for higher amounts, require collateral like equipment, inventory or real estate to secure the loan. If you don’t want to risk assets getting repossessed in the event of default, a personal loan keeps your business and personal finances separate.
- Your personal credit history will qualify you for the best interest rates. If your personal credit is stronger than your business credit score, you may be able to secure a lower interest rate on a personal loan compared to a business loan.
When It Doesn’t Make Sense to Use a Personal Loan for Your Business
A business loan could be the better choice if any of the following apply:
- You found a personal loan with no origination fee and a more competitive interest rate, but the lender does not allow the funds to be used for business expenditures. Using a personal loan meant for personal use could violate the loan terms and land you in legal trouble if discovered. A business loan ensures the funds can explicitly be used for qualifying business costs.
- You have a solid business plan and good or excellent credit. With a clear vision for your company and a positive credit history, you may qualify for favorable terms on a business loan. Business loans allow lenders to directly assess your company’s potential and are better suited when you have the financial reporting to demonstrate a thoughtful growth strategy.
- You need a loan of over $100,000 and plan to apply for an SBA loan product. The SBA provides attractive loan guaranty programs for qualified small businesses, but you must apply through an SBA-preferred lender using their business loan application process. For large capital needs with an eye on SBA backing, starting with a business loan makes the most sense.
Personal Vs. Business Loan: Which One Is Right for Your Business?
Ultimately, it’s a personal decision. Both can help meet funding needs, but you’ll need to evaluate loan offers and borrowing costs to determine which is most sensible for your financial situation. It’s equally important to read the fine print to ensure the loan proceeds can be used for the intended purpose to avoid issues later on down the line.
That said, there are several reasons why entrepreneurs might choose a personal loan over a traditional business loan, including:
- Less stringent eligibility guidelines: With a strong personal credit score and a consistent source of income, you may have a higher chance of being approved for a personal loan as compared to a business loan. Small businesses, especially newer ones, might struggle to meet the strict requirements of a business loan.
- Faster loan processing times: Personal loans generally have a shorter application and approval process, meaning you can access funds more quickly when compared to business loans.
If you decide on a personal loan for your business, lenders will typically look at your personal credit score rather than your business credit history. A higher personal credit score can lead to more favorable loan terms and interest rates. So, it is essential to maintain a good credit score to increase your chances of approval.
While there are a few key benefits to using personal loans for business purposes, there are also drawbacks to consider:
- Smaller loan amounts: Personal loans might have lower borrowing limits than business loans, which may not be sufficient to cover your business expenses.
- Personal liability: Since the loan is in your name, you are personally liable for repaying the debt. This could put your personal assets at risk in the event of business failure or inability to pay back the loan.
So, you should compare the loan options available to you and conduct a cost-benefit analysis to determine which best suits your needs. Before moving forward, it’s also worth taking into account the interest rates, repayment terms and potential tax implications of using a personal loan for your business.
Where To Get a Business Loan
Several banks, credit unions and online lenders offer personal loan products. However, not all lenders are the same, and finding one that is reputable and offers competitive rates can be challenging.
Most traditional banks provide business loans but may require applicants to have an existing banking relationship. Credit unions can also be a good source for business loans as they often have lower interest rates than banks.
Online lenders are rising in popularity due to their accessibility and the quick access to funding they provide over traditional banks. Still, it’s important to carefully vet online lenders’ reputations, fees, and loan terms. You also want to do some legwork to confirm you’re dealing with a reputable lender.
Researching a variety of options is key to finding the right loan product with the most competitive rates and terms suited to the business’s needs. Speaking with loan officers upfront is equally helpful to ensure you understand all the lending requirements.
