When it comes to money, it’s smart to draw a clear line in the sand between your business personal finances. However, the choice isn’t always so clear cut when it comes to business credit vs personal credit.
It’s true that you should start establishing good credit for your business right out of the gate (or at least as soon as possible). Good business credit can help your company qualify for funding and can save you money when your business needs access to low-cost working capital in the future.
Yet building a solid business credit profile takes time — time some business owners don’t feel they have to wait. As a result, some people will opt to leverage their own good personal credit in the hopes of qualifying for affordable financing options sooner rather than later. One way business owners sometimes accomplish this goal is by taking out personal loans for their businesses.
In this article we’ll cover:
- What Is a Personal Loan for a Business?
- Why Do Business Owners Use Personal Loans for Their Business? (The Benefits)
- How to Use Personal Loans to Start a Business
- Types of Personal Financing Used for Businesses
- Personal Business Loans
- Personal Credit Cards
- Home Equity
- Personal Business Loans for Bad Credit
- Are Personal Loans for Businesses Tax Deductible?
- Is It Better to Get a Personal Loan or a Business Loan?
- Downsides of Personal Loans for Businesses
- How to Make the Right Choice for Your Business
What Is a Personal Loan for Business?
You may already be familiar with the concept of personal loans in the consumer space. You apply for a loan and, with most lenders, a lump sum is deposited into your checking account once you’re approved for financing. After the deposit, you can spend the money however you please. You make fixed monthly payments back to the lender, pay a fixed rate of interest, and you do all of that over a fixed period of time.
Many people use this type of financing to consolidate expensive credit card debt, pay for home improvement projects, or to pay for medical bills and other unexpected expenses. What you might not realize is that, unless your lender prohibits it, many personal loans can be used for business purposes as well.
Why Do Business Owners Use Personal Loans for Business?
Many business owners opt to use personal loans for business because the approval process tends to be easier, especially for startups. When you apply for a personal loan for your business, it’s your personal creditworthiness (aka credit history and credit score) and personal capacity (aka income and debts) that determine your ability to qualify for a loan. Your business’ credit, cash flow, annual revenue and debt isn’t relevant. As a result, if you have good personal credit, decent income, and an acceptable debt-to-income ratio, you’re likely to qualify.
Because your business credit rating and annual revenue aren’t considered by the lender when you apply for a personal loan for your business, this type of loan can be an appealing option to the business owner who may have trouble qualifying for a traditional small business loan. But there are downsides to consider as well.
How to Use Personal Loans to Start a Business
We’ll go over some potential downsides of personal business loans later, but first let’s cover some of the different personal financing options small business owners commonly use to start a business.
1) Personal Business Loans
For business startups, borrowing money can be tricky. One option you might want to explore, if you have decent personal credit, is applying for a personal loan and using it to finance your business’ startup costs. Some lenders may specifically prohibit using the funds for a business, so be sure to read the loan terms and conditions before you apply to make sure this is allowed by the lender.
Personal Term Loans
A term loan is a loan type that has a fixed term where the amount will be repaid. On the consumer side, a personal term loan is usually just called a personal loan.
A short-term personal loan usually has to be repaid within a year. Long-term personal loans, on the other hand, might feature repayment terms as long as 60 months or more.
Personal business loans may be available both from traditional financial institutions and from online lenders. These types of loans are generally unsecured and have an easier application process when compared with business loans like SBA loans or traditional business bank loans. Personal business loans may also offer lower rates than some other types of business financing since you’re providing a personal guarantee, though the size of the personal loan you can get approved for is often smaller.
Personal Business Loan Rates
Thinking about using a personal loan for business purposes? If so, you might be able to qualify for a low interest rate if your personal credit scores are in good shape. According to the Federal Reserve, the average finance rate on a 24-month personal loan from a commercial bank was 10.63% in May 2019.
As with any type of personal financing, better personal credit scores tend to garner lower interest rates and better loan terms from lenders. On the other hand, if your personal credit isn’t in the best shape, you’re likely to be offered higher rates and less attractive terms.
2) Personal Credit Cards
Credit cards can be another way to leverage your personal credit profile to fund your business. As a business owner, you’ll have two different options when it comes to applying for a credit card — business credit cards and personal credit cards. And while your personal credit will matter when you apply for either type of card, there are some differences between these two types of plastic. Namely, business credit cards may not show up on your personal credit reports and personal credit cards will likely never show up on your business reports.
Many (though not all) personal credit card issuers don’t restrict you from using personal credit cards for business expenses. You could also hurt your personal credit scores if you heavily utilize the account for business purchases and show a high balance-to-limit ratio on your credit reports. Finally, a personal card won’t help you build business credit, which is important for the future of your company. Your best bet is generally to use a personal credit card for personal expenses and a business credit card for everything business-related.
Personal Credit Card Rates
If you decide to open a separate personal credit card account for your company, the Federal Reserve reports that the average interest rate is currently 15.13%. According to Experian, you should aim for credit scores of 740 or higher if you want to qualify for the best interest rates from lenders. There are still plenty of personal credit cards available if you have a FICO score far lower than 740, but you might not be able to score the lowest rate or the best terms an issuer has to offer.
3) Home Equity Lines of Credit & Loans
Another type of personal financing you may be able to use for your business is a home equity loan or line of credit, commonly called a HELOC.
With a home equity loan or HELOC, your home itself serves as collateral. This means that if you can’t keep up with payments, you could lose your house. Because of the risks involved with this type of financing, the Federal Trade Commission recommends talking to an attorney, financial advisor, or someone else you trust before making the choice to use your home as collateral.
Home Equity Loan Rates
Because you’re securing a home equity loan or HELOC with the value you’ve built up in your home, there’s considerably less risk involved for the lender. (If you default on the loan, the bank can take your house and sell it to help cover its losses.) As a result, you may enjoy a lower interest rate when compared with other financing options — especially unsecured business loans.
The average interest rate for a home equity loan is 5.8% (6.74% for a HELOC of $30,000). Credit score requirements for home equity loans or HELOCs will vary from lender to lender. According to Experian, you’ll generally need a minimum FICO Score of 660 or higher to qualify. If you want to secure good terms, a score over 700 is best.
Personal Business Loans for Bad Credit
Unfortunately, if you’re looking for personal loans to fund your business and you have poor credit, you’ll probably need to search for other options. Personal business loans for bad credit generally don’t exist. As an alternative, you might consider one of the following:
- Bootstrapping — A business funding method that relies on your own income and savings to get started.
- Crowdfunding — Platforms that allow you a chance to try to raise funds for your business based on donations, sharing equity in your company, and as an alternative way to find nontraditional lenders. These sites do have downsides though and while they don’t have an interest rate like a loan, there can be fees and some platforms take a cut of the money raised for administering the platform.
- Loans from Family and Friends — Some business owners opt to borrow money from loved ones instead of turning to traditional or online lenders.
Are Personal Loans for Business Tax Deductible?
Are you using a personal loan for business reasons? If so, you should talk to your accountant. There’s a definite possibility that if you’re using a personal loan for your company (and you can prove it) or if the loan was taken out for mixed personal and business purposes, some or all of the interest on the loan may be tax deductible.
It’s always best to keep business and personal finances separate, as things can get mixed up pretty easily. If you’re wanting to deduct costs related to a business loan, taking out a personal loan may make things pretty complicated.
Is It Better to Get a Personal Loan or a Business Loan?
Before you can decide whether a personal loan or business loan is best for you, you’ll need to do some homework. Both options come with risks and rewards, and you will need to figure out which ones you’re most comfortable taking.
Whenever you’re weighing different financing options it’s crucial to understand the terms before you fill out a loan application. Interest rates, of course, are important. But they’re only part of the picture. You also should understand the risk you’re taking in the event things go wrong.
You should be able to answer these questions about the loan:
- What are the qualification requirements?
- Will the loan appear on my personal credit reports? What about in the event of a default?
- Do I have to sign a personal guarantee?
- Is any collateral required from my business or from me personally?
- Is there a prepayment penalty?
- What is the interest rate for financing?
- In addition to interest charges, are there any fees (origination fee, monthly fee, annual fee, etc.)?
There’s a lot of information involved in feeling comfortable with the financing product before you apply. To compare loans and get matched to the top financing options for your business based on your business and credit profile, sign up for free on Nav.
Downsides of Personal Loans for Business
While personal loans can be an easier option for accessing working capital, especially for newer businesses without an extensive business credit history, there are definitely downsides to these options specifically. Here are a few downsides to consider before you apply for a personal loan to fund your business:
- Personal loan amounts tend to be smaller than business loan amounts.
- With personal loans for business, you may accept a higher level of personal risk if your business can’t keep up with the payments. For example, if you apply for a home equity line to finance your business, you’re putting not just your personal credit at stake, but your home as well.
- A personal loan won’t help you build business credit. Personal loan payment history is not reported to the major commercial credit bureaus, so newer businesses may be better off accessing a business line of credit with a personal guarantee (here’s our list of top lenders in the space), so they can get the capital they need, leverage their personal credit to get the rate and amount they want, and build business credit as well so their financing options can expand down the road.
Making the Choice
As a business owner, the good personal credit you’ve built can be an asset to help your company secure financing. But just like signing a personal guarantee, taking out a personal business loan to borrow money for your business means that you’re putting your neck on the line for your company. If you’re not careful, your business can hurt your personal credit scores.
You need to understand this risk, and be 100% comfortable with it, before you decide to use a personal business loan for your company.