While many might assume a business loan is the best way to finance your business, personal loans are still a popular and practical option. Both methods have their advantages and disadvantages.
Before taking any action, it’s essential to consider your business and personal needs, and examine the potential consequences and implications of either choice. Here we’ll dive into both types and weigh the pros and cons of each.
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How do small business loans work?
Small business loans provide funding that your business might need for a variety of purposes. A loan might fund buying equipment, paying salaries, ramping up marketing or investing in technology. There are a variety of loan options available for small business loans, including lines of credit, SBA loans, term loans, cash advances, invoice financing and equity financing.
Business loans can be short or long-term, and often they require a good bit of paperwork about your business, such as financial statements and business projections. Small business loans can be either secured (with collateral) or unsecured, and in most cases they will still require a look at your personal credit history.
Some business loans can be obtained very quickly. Cash advances and invoice factoring are two types of loans that can be funded very fast and can also be very short-term in nature. Other business loans, such as SBA loans, can require large amounts of paperwork and can potentially be longer-term, such as 10-year loans or even up to 25-years when real estate is involved.
How do personal loans for small business work?
Getting a personal loan for business use is often simpler than getting a business loan. With a personal loan, your personal financial information will be reviewed, including your credit history and sometimes your employment or income history.
Personal loans are usually unsecured, meaning you don’t need collateral. The loan amounts offered are typically smaller, generally between $1,000 to $100,000 and typically shorter-term, lasting for anywhere from 6 to 60 months.
There is one significant downside to getting a personal loan for business purposes: if your business is unable to pay back the loan, then you’ll personally owe the money and be liable for the outstanding loan balance.
Another option in the personal borrowing category is personal credit cards. Many small business owners will obtain a personal credit cards as a way to either access cash advances or pay for business expenses.
Often a business can apply for a business credit card, and provide a personal guarantee. This type of borrowing is really like a personal debt, since your are obligated personally if the business doesn't repay. However, it can help build business credit.
Business loans: what are the pros and cons?
Personal liability can be limited should the business default
Loans can be difficult to obtain without established business credit history
Can qualify for large loan amounts and extremely long repayment periods
A personal guaranty may be required
Some of the ‘pros’
When deciding whether to take out a personal loan or a business loan, there are a lot of things you need to consider. A business loan can help separate your business from your personal finances, which is especially important as your business grows.
Sometimes, though not always, business financing may limit your personal liability if the business defaults or encounters other financial difficulties during the loan term. Alternative lenders, like companies that offer non-recourse receivables factoring, are the most likely lenders to provide business loans with limited personal liability.
An important benefit of using business financing responsibly is that it can help you build your company's credit history and business credit score. By doing that, your business can have other opportunities in the future, such as borrowing to higher limits or accessing new financing without personal liability.
Some of the ‘cons’
On the downside, business loans can be difficult to obtain for a newer business or if your business hasn’t established its own credit. It can also be hard to get certain business loans if your personal credit score is somewhat low. For example, even though SBA loans are a type of business financing, SBA lenders require credit scores of 650 or so to qualify.
Also, applying for business loans can be tedious and lengthy, depending on the type of loan. The process often requires a good deal of paperwork, and many types of loans take longer to receive a decision then personal loans.
For a new business who has an immediate cash need to help it thrive or grow, waiting for loan approval on business financing could mean mean missed business opportunities.
Depending on your situation and the type of loan, many business loans still require a personal guaranty. This means that you are personally liable for repaying it if the business defaults and does not repay the loan.
Personal loans for small business: what are the pros and cons?
Can be easier to obtain than business loans, depending on your personal credit
Lending limits are typically lower and interest rates are generally higher compared to business loans
Many personal loans are unsecured, meaning you don’t need collateral
You won’t build business credit through repayment
Some of the ‘pros’
A prime benefit of personal loans is that they can be easier to obtain than business loans. Typically, personal lenders will review your personal credit score and finances to make their decisions.
Small business lenders, on the other hand, usually review both your personal credit and business credit. Plus, they may ask for a business plan and a number of other financial statements and business records. This can make the small loan process more time consuming. Personal loans can usually be obtained faster.
Another benefit of using a personal loan for your business is that personal loans are usually unsecured. This means you will not offer collateral (such as a vehicle, property or equipment) to secure the loan. For a small business loan, sometimes a lack of collateral will prevent you from getting a loan.
Some of the ‘cons’
A major drawback of using a personal loan for your business is that the loan sizes can be lower compared to typical business loans. Therefore, you may not be able to get all the money you need with a personal loan.
Personal loans often have higher interest rates than the best small business loans. This means you may have higher interest payments, and these then make it more difficult to repay the loan.
When you use a personal loan for your business, you are not building business credit. Building your business credit can be very helpful as your business grows, leading to additional financing options and lower cost borrowing.
On final drawback of a personal loan for your business: if the business defaults on the debt, your personal credit profile will be negatively impacted. This could be a really big hole to get out of if your business fails and your personal credit is hurt badly as well.
Hot do you get a business loan vs. a personal loan?
Finding and applying for a small business loan
Getting a business loan can be a simple or complex process, depending on the loan type. Below is a table showing the most common types of business loans with indications of how easy the application tends to be.
For many loans, in addition to lenders reviewing your personal credit score, they’ll also want to see additional information about your business. This includes reviewing your business credit history, if available, plus your business finances, sometimes a business plan, and information on any collateral for the loan.
When it comes to finding a business loan, you have a lot of options including online lenders, local and regional banks, credit unions and alternative non-bank lenders. For most businesses, it's best to work with a financing broker with experience in a wide variety of loan types.
Common types of small business loans
To find a business loan you’ll want to:
Review the various loan types available. There are many different types of small business loans options available, so you should read about them and see which you think might best fits your business needs.
Either find lenders or work with a lending marketplace. Each lender has different requirements and loan offers. It can be hard to research lots of them at a time. Many businesses prefer to use a lending marketplace instead. This allows you to apply once, and the lending marketplace will work to match you with lenders and loans you qualify for.
Compare loan cost and monthly payments. When comparing loan offers, look at the APR (if possible), loan term, fees and monthly payment. Consider what terms could work best for you. For more, see How to Calculate the True Cost of Financing for Your Small Business.
Gather any necessary loan documents and apply. Loan applications require differing amounts of paperwork depending on the type of loan. With a lending marketplace, you usually start with one basic application and a small set of application documents. The small business loan application process can take just hours or days, in the best case, or weeks for the harder programs such as SBA loans. Once you apply, look for a pre-approval. Once that's obtained, the lender will ask for any additional documents required to fund the loan.
Finding and applying for personal loans for business
You can apply for a personal loan and have a decision in as little as a day, or a few days, depending on the lender. When you apply, the lender will review your personal credit, your income and your other debts.
Many small businesses end up with personal loans, or even personal credit cards, when they need funds for their business but don't have a track record yet and haven't established your company’s credit history.
The types of lenders for personal lenders is somewhat similar to the types of small business lenders - you’ll find options in local and regional banks, credit unions or online lenders. Increasingly, online lenders are being very aggressive in making personal loans for whatever purpose you need one.
To apply for a personal loan, you'll want to:
Review minimum qualification requirements. Research lenders, since they all have different minimum criteria you need to meet. Some lenders specify that personal loan funds cannot be used for business purposes but only for personal expenses, so be sure to check on that.
Apply. Many personal loan lenders make it easy to compare loan terms through a pre-qualification process. This usually only requires a "soft credit check", which won't impact your credit score. Lenders use a pre-qualification process to quickly show you loan terms you might qualify for.
Compare offers and apply. Be sure to review the loan amounts of your offers to ensure you are getting the amount you need. Also, review the APR and monthly payments for each of the loans.
Once you’ve chosen a lender, you’ll submit a formal application, and this will require a hard credit check. Lender may also ask for additional supporting documentation, such as your pay stubs or tax returns.
Should I get a business loan or a personal loan?
The answer will always depend on your situation and your funding needs. Here are some quick guidelines on when each type of loan makes sense:
When does a business loan make sense?
If your business can borrow without using a personal guaranty, this is almost always the way to go. This will let you not put your personal assets and credit profile at risk.
If you need to borrow a lot of money, you're probably best getting a business loan - they tend to be larger.
If need money very fast, you may get funds within a day with a working capital loan, or merchant cash advance for your business.
If you want to build your business credit, a business loan can help you do that.
If you have collateral to offer, this may make obtaining a business loan more feasible. Unsecured loans are always a bit harder to obtain then secured loans.
When does a personal loan for business make sense?
If your business is a start-up or hasn’t built much credit history yet, you may not have a choice. You'll have a better chance of being approved for a personal loan since those are based on your personal financial history.
If you have a little time and don't need funds same-day the personal loan route can work. With that said, there are now some online personal loan lenders offering funding within one business day. Many of these highlight debt consolidation as a primary benefit of the debt, but those loans can be used for other purposes.
If you don’t have collateral — or don’t want to use any of your business collateral — a personal loan can make sense. Most of these are unsecured.
Conclusion: Our Final Thoughts on Business Loans v Personal Loans
There are pros and cons for both business and personal loans, and each should be considered in relation to where you are in your journey as an entrepreneur, and how much you're willing to put on the line to achieve your vision.
A business loan or business credit line is a great option when you need money for a specific purpose, you have a solid business plan to back it up, or a good credit score, or business collateral to offer. Business loans and business credit lines are typically used to finance large expenses, such as buying or expanding a business, hiring employees, and purchasing inventory or equipment.
A personal loan, on the other hand, is a solid option when you need money for a smaller business goal, you don't have collateral to offer, you want a simpler application process and either your business doesn't yet have the credit history to stand on its own.
Either way, if you have ambitious goals and a clear roadmap to success, there are many options available to get your business financed, and put you on the way to achieving big dreams with your small business.