Separating your business and personal finances is a good way to run your business. Unfortunately, it’s not always that simple. Entrepreneurs may find themselves in situations where a personal loan is the only way they can get the money they need to pursue their entrepreneurial endeavors. If you’re weighing the possibility of a personal loan for your business, here’s what to consider.
Can You Use a Personal Loan for Your Business?
The short answer is “yes, if you qualify.” When you get a personal loan, it’s unlikely the lender will carefully scrutinize how you spend the funds. But if you read the fine print of the loan agreement, you may discover it prohibits borrowers from using loan proceeds for business purposes.
That’s not a problem if you’re able to repay the loan. The lender isn’t going to ask for proof of how you spent the proceeds to make sure you didn’t use it for business expenses. But if you can’t pay back the loan, and you wind up in bankruptcy, it’s possible that violating the loan terms could affect your ability to wipe out that debt.
Pros and Cons of Personal Loans for Business
As with all types of financing, there are pros and cons to using personal loans for business:
- May be easier to qualify, especially for startups
- Predictable monthly payments
- Can use Annual Percentage Rate (APR) to shop around
- Lower interest rates than some business loan options
- Personal guarantee required
- Reports to personal credit
- Won’t help build business credit
- Interest and fees may not be deductible
- Smaller loan amounts than some business loans
Is it Easier to Get a Business Loan or a Personal Loan?
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, your personal creditworthiness (credit history and credit score) and personal capacity (income and debts) determine your eligibility.
Your business’ credit, cash flow, annual revenue and debt isn’t relevant. As a result, if you have good personal credit, decent income, and, in some cases, 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.
Personal loans may be available both from traditional financial institutions and from online lenders. These types of loans are generally unsecured and the application process is easier when compared with business loans like SBA loans or traditional business bank loans.
Business Loans vs. Personal Loans: Which is Better for Business?
When comparing a business loan to a personal loan used for the business, one consideration is the impact on your credit scores. A personal loan is likely to be reported on your personal credit reports and can affect your personal credit scores. If you’re able to pay the loan on time, your credit scores may benefit. On the other hand, late payments will hurt your personal credit. And in some cases, the additional debt may make it more difficult to qualify for other loans even if the loan has a positive payment history.
In addition, a personal loan automatically comes with a personal guarantee. That means that if you don’t repay the loan, the lender can try to collect from you personally. Even unsecured personal loans carry some risk despite the fact that there is no collateral, as lenders may sue if the loan isn’t repaid. It’s worth noting that some business loans also carry a personal guarantee, though not all do.
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; ideally, before you fill out the 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 will want to consider 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?
- In addition to interest charges, are there any fees (origination fee, monthly fee, annual fee, etc.)?
It’s worth repeating: it’s important to understand the risk you’re taking with a personal loan and think through the implications if your business doesn’t succeed. 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. Starting a business is risky, and many don’t make it past the five year mark. Can you afford the payments if you go out of business?
When To Consider Using a Personal Loan for Business
If you can qualify for a business loan with good terms, it’s often the best choice for your business. You’ll clearly separate your business and personal finances, you may be able to deduct interest and other costs, and you don’t put your business at risk because you have commingled your finances.
There may be times, however, when it’s simply not possible for small business owners to qualify for a business loan. You may be starting a new business, and businesses less than two years old often have trouble qualifying for business loans. You may not have sufficient business revenues to qualify, or perhaps revenues have been declining recently. Or your business may operate in an industry that is tough to finance; such as multilevel marketing or businesses involving the sale of restricted items such as guns, alcohol or cannabis, for example.
Interest rates are another consideration. Many small business financing options don’t provide an Annual Percentage Rate (APR) to help you compare costs. Some loans can be very expensive, with effective interest rates in the high double digits. (Use these small business loan calculators to help you understand the cost of business financing.) High-cost financing can significantly impact the profitability of the business.
Personal loans tend to carry interest rates on the higher side when compared to other consumer loans, like mortgages. But they may be lower than high-rate business loans.
And rather than monthly payments, which are typical for personal loans, business financing may come with repayment terms that require weekly or daily payments that can significantly impact cash flow.
Is it Easier to Get a Business Loan or a Personal Loan?
Qualifying for a personal loan usually involves two main factors: your income and your personal credit scores. If you have good credit scores and sufficient income to qualify, it shouldn’t be terribly difficult to get a personal loan.
Qualifying for a business loan usually involves three main factors: business revenues, personal and/or business credit, and time in business. A fourth factor— the industry your business is in— can also come into play as lenders may not want to lend to businesses in specific industries.
There may be more hurdles to navigate when applying for a business loan. Most lenders require business bank statements to verify business revenues. (If you don’t use a business bank account, make sure you get one.)
Traditional business loans, such as bank loans or loans guaranteed by the U.S. Small Business Administration, may also require you to provide a business plan, tax returns or financial statements. The approval process can take weeks or months. (Online lenders can often make decisions in a matter of hours or days.)
How to Find and Apply for a Personal Loan for Business
Lenders will market personal loans for debt consolidation, paying for home repairs, or even for funding vacations, but they aren’t likely to advertise personal loans for business. Instead, you’ll shop for a personal loan and then decide how you want to use the proceeds.
A personal loan usually provides a specific amount of money and comes with a fixed repayment schedule. The best personal loans carry low interest rates, and those are usually based on your credit scores. Excellent credit will earn you the lowest rates.
Unless you apply in person at your bank or credit union, you’ll likely apply for a personal loan online. You’ll fill out the application online, the lender will check your credit, and you’ll get an answer quickly. Before you apply, see if you can find out what the lender’s minimum credit score and/or income requirements are so you don’t waste time applying for a loan you aren’t likely to get.
Alternative Options to Personal Loans for Business
A credit card can be an alternative to a personal loan. In addition to providing a convenient way to pay for purchases, credit cards offer access to a line of credit you can pay off over time. Some credit cards offer 0% introductory rates, but after that time period the rate will be much higher. For that reason, credit cards are best for short-term financing.
If you’re considering using a credit card, be sure to consider a business credit card. Qualification requirements are similar; they usually require good personal credit and sufficient income from all sources. But some business credit cards don’t report to personal credit and most will help build business credit. They can be a great way to separate your business and personal finances. Finally, business credit cards are often available to startups.
If you’ve tried unsuccessfully to get a business loan from your bank, you may want to look into alternative financing. There are many different business financing options that may fill the gap.
If you’re considering a personal loan because you have bad credit, you may find it difficult to qualify. Crowdfunding, microloans, invoice factoring or business cash advances may be options to consider.
If you have a newer business, startup financing options may include microloans, crowdfunding, business credit cards, or vendor financing. Some SBA loans are available to startups.
If you have good credit, at least a year or two in business and documented revenues, you may qualify for a variety of financing options including:
- Business line of credit
- Term loan
- Business cash advance
- Equipment financing
- Invoice financing
- SBA loans
- Vendor terms
And finally, there’s always the option of borrowing from friends and family. It can be awkward and is fraught with potential pitfalls, but it is a common way for many business owners to get their initial financing.
The Bottom Line
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 that good credit 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.
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