When businesses hit that inevitable speed bump, they often seek business loans to supplement their lack of cash. But maybe your business hasn’t been open for more than six months, and you might not meet the standard requirements for revenue or cash flow. Much like any other critical business decision, it never hurts to explore other options. In this case, your alternatives include business credit cards, investors, and often misunderstood personal loans.
At first, it doesn’t seem like it would ever make sense to use a personal loan for business purposes. But for some business owners, personal loans might offer fewer disadvantages than the kind of business loans at their disposal. To decide which option is right for your needs and circumstances, you have to know which questions to ask and which numbers deserve the most attention.
There are distinct factors, like personal credit score, interest rates, fees, repayment terms, etc. Which is more important: a higher borrowing amount or a lower APR? It would be best if you also considered how your intended use of the funds would affect repayment and the benefits of establishing a relationship with a reputable financial institution. With so many business funding sources to choose from, it will probably take time to find the most advantageous business loan within your reach.
In this guide, we’ll lay out every question to ask yourself when choosing between a business loan or a personal loan. Remember: the number one objective is to grow your business, not to get the best deal.
The comparison between business loans and personal loans depends on the person applying for them. One person (business owner or not) could have an easier time qualifying for business loans, while the opposite could be true for someone else. So, you can’t say that personal loans will always be cheaper or that business loans will always be harder to qualify for. When you take subjective factors out of the picture, the two are pretty similar. The only real differences are the number of requirements and the intended use of the funds. Personal loans have much fewer standards, and we’ll explain why later on.
Both options come in various forms, like lines of credit, short-term loans, long-term loans, etc. You can find business loans and personal loans with somewhat similar borrowing limits and terms. But unlike personal loans, certain types of business loans are specifically geared towards specific purposes.
This depends on the financial institution. If you’re looking for a hefty term loan from a commercial bank, you might have to use the money for a specific purpose. The bank would likely require a business plan that shows how your desired investment will improve revenue and profitability in the coming years. In other words, your intended use of the funds would have a direct influence on your chances of approval, borrowing amount, and interest rate. More substantial and cheaper bank loans typically require more information about your business’s future in general. Your business plan should clearly state why your desired investment makes sense at this time and why it’s necessary for achieving your long-term goals.
However, most other institutions do not require a business plan or a specific purpose for the money. You can essentially spend the money on anything you want. But that doesn’t mean you shouldn’t have a concrete plan for executing your investment and paying back the debt.
There are also numerous types of business loans, and their requirements are sometimes based on their intended purpose. Equipment financing loans, for example, are designed to purchase expensive equipment. Depending on the institution, the application might require information about the piece of equipment at hand, like its current market value. Invoice financing is directly based on your accounts receivables‘ value, so you’d need information about specific invoices.
Other types of business loans, like merchant cash advances or business lines of credit, are best suited for specific purposes. Unlike term loans, institutions usually recommend using these two options to offset temporary dips in revenue. But you probably won’t need to disclose your purpose to the institution.
Personal loans can technically be used for the same purposes as business loans. The traditional personal loan works like a business term loan. Other types of personal loans exist for purposes that are not conducive to the conventional loan structure.
Institutions strongly advise against using personal loans for business purposes. This is primarily because mixing personal and business expenses can result in a slew of hazardous issues. We’ll delve further into those issues later on, but let’s say your accountant will thank you for keeping your personal and business bank accounts separate.
Thus, most people use personal loans for personal matters like student debt, medical bills, or home renovations. There should be a clear benefit to paying off the full expense now, as opposed to little by little.
Their owners personally financed many successful businesses at some point. They might have used the money to cover business expenses or payroll for a couple of months. After all, banks tend to favor business loan applicants with “skin in the game.” Using your own money to keep the business alive shows the bank you are significantly less likely to let the business fail.
The three chief factors to consider in this situation are accessibility, default risk, and tax complications (which we’ll get to soon). Due to the vast difference in requirements (which we’ll get to in just a bit), you might be able to obtain a personal loan with more advantages than your best offers for business loans. And as long as the money comes from a reputable company, well, money is money. It’s ultimately up to you to make sure that the way you spend and organize this money does not hurt your business.
You should also keep in mind that if you default on a personal loan, the lender might have the right to seize your personal assets. On the other hand, if you default on a business loan, the terms would most likely put your business assets on the line.
As mentioned in the previous section, personal loans and business loans have very different requirements. The most important business loan requirements tend to differ from institution to institution. For this reason, you could find a business loan and personal loan that doesn’t have to share a single paramount requirement.
Here are the general criteria for each:
Most personal loan companies are concerned with just two numbers:
The higher you score in these areas, the more advantageous your loan will be regarding borrowing amount, term length, and interest rate. Yes, that’s all you need. If you have a solid credit score and personal income, you shouldn’t have much trouble obtaining a substantial personal loan.
But let’s say you aren’t so strong in those areas. Does that automatically mean personal loans are out of the question? Possibly. This brings us to the greatest difference between business loans and personal loans. You can have sub-par credit and personal income and still access a reasonably-priced business loan.
Banks and other traditional institutions usually place tremendous value on credit scores. If your score is less than perfect, your application will most likely be denied. Online and alternative institutions, however, frequently approve applicants with mediocre or even poor credit. These loans are not as advantageous as bank loans, but they provide necessary funding while allowing the borrower to build credit during the repayment process.
But online and alternative institutions won’t work with just anybody. Applicants with sub-par credit must fulfill numerous other requirements to show that they can be trusted. This includes cash flow, time in business, revenue, and profitability. The status of your industry and your ability to provide collateral may affect your application as well.
The importance of each factor depends on the institution, along with the type of loan. For example, the number one requirement for a merchant cash advance is consistent debit and credit card sales. Payments for a merchant cash advance are deducted from debit and credit transactions. Thus, the institution is more concerned with your future sales than your past.
Aspiring business loan applicants should figure out where they range on all potentially relevant factors. This will narrow down your search for the right institution and loan product.
Ask any accountant to name their number one piece of advice for new entrepreneurs. Odds are, their answer will be to open a business bank account so that they can keep personal and business finances separate. Using one account for personal and business expenses makes it extremely difficult to pull accurate cash flow data, profitability, etc. Business owners must also show proof of certain business expenses to receive the associated deductions. This is harder to do without a business bank account, and it could give the IRS reason to suspect false claims.
Additionally, you cannot get a business loan without a business bank account. Your only option would be a personal loan, which goes into your personal bank account. If you use this money for business purposes, your accountant will have one more thing to separate from the rest of the account when tax season rolls around. On top of business expenses and business income, your account must separate all loan-related transactions.
Some banks only let you open business accounts if you meet certain requirements. This could include a monthly minimum deposit or a minimum daily balance. Younger businesses might have trouble fulfilling these requirements, and failing to do so could result in fees. The solution is to open a second personal bank account and use it as a business account.
Why would a business owner choose a personal loan over a business loan? Maybe they can’t meet the general requirements for time in business, or they’ve been offered a personal loan with an incomparable interest rate. Let’s go over what to do in these situations and explain other factors that could shift an entrepreneur towards a personal loan:
Most business loans require at least six months in business. Startup loans exist for brand new businesses, but they are not easy to obtain, even with excellent credit. Taking a loan with almost no time in business is also a huge risk since you have no certainty that your business will eventually generate enough revenue to sustain itself, let alone make monthly payments. If you can fulfill the main requirements for a startup loan, you might as well use those strengths to pursue another, substantially cheaper source of funding.
In addition to a personal loan, you should consider a business credit card. You probably won’t have to look too far to find affordable offers for new entrepreneurs (i.e., 0% intro APR). Business credit cards are a great first step in separating personal and business finances. And you’ll build credit quickly by paying back both debts.
Your personal loan’s interest rate and term length depend on just two factors: credit score and annual income. For this reason, you might find that your best offer for a personal loan is significantly cheaper than your best offer for a business loan. Though business loans carry several additional benefits, it’s hard to argue against a clear difference in cost.
But remember: this scenario is likely only possible with flawless personal credit. If you have excellent credit and at least six months in business, you should be able to qualify for a reasonably-priced business loan as well. So, before taking an attractive personal loan offer, make sure you’ve researched the many business lenders that work with new entrepreneurs.
Personal loan companies aren’t known for distributing multiple rounds of funding. Most borrowers take one loan and never talk to the company again.
Business lenders, on the other hand, typically strive for long-term partnerships. They know that unforeseen issues never stop for small businesses and will only increase when the business grows. Business owners must continuously borrow money to dodge their endless barrage of curveballs.
Establishing a relationship with a business lender allows you to access increasingly advantageous loans in increasingly shorter time frames. Once you pay off your first loan, you’ll probably have no trouble qualifying for a larger, cheaper loan the moment you need it. The lender will also come to learn the ins-and-outs of your business and provide helpful advice for managing your finances.
As you can see, it’s understandable to take a personal loan over a business loan, but only if the factors above have been considered. First and foremost, you need excellent credit and a solid annual income. Unless you’ve been in business for less than six months, you should be able to get some decent offers from a few online or alternative business lenders. In other words, don’t make any comparisons until you are sure that you’ve explored every reputable lender that frequently works with growing businesses.
If your offers from both options are comparably priced, consider the value of a long-term partnership. Odds are, you’re going to need additional funding again at some point. Establishing a relationship with a business lender now will make you much less stressed about your business’s future. If you pay off your first loan on time, you’ll likely be able to access your second loan in a matter of hours, even with rocky cash flow. Your lender will know you and trust you, and this is an advantage that can’t be measured on paper.
You can’t get a personal loan without excellent credit and steady personal income. Neither of these things is common for new entrepreneurs. Online and alternative business lenders wouldn’t exist if there weren’t so many entrepreneurs with poor credit.
If you can meet the credit and income requirements for personal loans, the next areas to consider are interest rates and terms. Most personal loans are term loans with strict, non-negotiable repayment systems. However, several online and alternative business lenders let you choose from various repayment systems and can even customize your terms to accommodate your unique cash flow challenges. So, before considering a personal loan, you should ask yourself if a term loan is really the right type of loan for your circumstances.
The availability of different loan structures and a long-term partnership can offset a slight cost advantage for a personal loan. If there were any reason to dismiss business loans altogether, it would be because your business is less than six months old. As long as you fulfill this requirement, business loans are usually the logical choice.
At this point, you should have an idea of the criteria that can sway you towards either direction. If you’re still unsure which loan makes sense for you, it’s time to research sources of both options.
You won’t know what you can qualify for until you ask. This is a big decision, so don’t be afraid, to be honest with each institution regarding requirements and goals. No reputable institution would advise you to choose their product if they didn’t believe you’d be able to qualify or pay it back. The right option will be what’s best for your business, your credit, and your day-to-day responsibilities. But you won’t have the comfort of knowing you chose the right option unless you see what’s out there. It’s a long process that will make you much more knowledgeable about one of your most vital resources: business financing.