For an entrepreneur trying to launch a small business, raising enough cash to get off the ground can be a challenge. Many small business owners may turn to loans to tide them over, but it can be difficult to get a small business loan if the company doesn’t have a strong financial history yet.
In those situations, the business owner may seek to take out a personal loan instead. But before they do, it’s important to know the differences between personal and business loans and understand which is best for their circumstances.
What is a Personal Loan?
Personal loans allow individuals to borrow a lump sum of money from a lender, bank or credit union, and repay it through fixed monthly payments, with interest. They’re usually taken out for personal expenses, like home renovations, purchasing major appliances or covering medical bills. Personal loans may be secured or unsecured. A secured personal loan is backed by collateral, something valuable like a home or vehicle. If the borrower fails to pay back the loan, the lender may take the collateral to recoup their losses. An unsecured personal loan, however, is approved primarily on the applicant’s income and credit history.
What is a Business Loan?
A business loan is designed specifically for business purposes, like purchasing property, materials or equipment, or covering payroll and other expenses. Business loans can be either secured or unsecured. For secured loans, the business puts up collateral like property or equipment to back the loan. Business loans are available from banks, credit unions, nonprofits and government lenders, such as the Small Business Administration.
Can You Use a Personal Loan for Business?
In some cases, an entrepreneur may be able to take out a personal loan to support their business — if the lender allows it. In other cases, a business owner might use a personal loan to cover their living expenses so they can invest more of their own money into their company. Before taking out a personal loan for business purposes, the applicant should talk to their lender about what they plan to do and confirm that they may use the loan for that purpose.
Advantages of a Personal Loan
- Simple approval process: Personal loan applications are typically simple to fill out. Applicants will need to provide personal identification and proof of income so the lender can check their credit score and credit history. Final approval depends on the applicant’s ability to repay the loan, and approval is not guaranteed.
- Collateral optional: Secured loans may offer larger borrowing amounts and better terms, but unsecured loans don’t require collateral. Applicants can decide which option works best for their situation.
Disadvantages of a Personal Loan
- Smaller loan amounts: Personal loan amounts are typically much smaller than business loans and may not cover all the business needs.
- May not be able to use it for business at all: Many lenders prohibit the use of personal loans for business expenses, potentially making it harder to find one that would approve a loan for that purpose.
Advantages of a Business Loan
- Builds business credit: A small business loan is one of the best ways to build credit for the company. Better credit ratings could lead to better terms on financing in the future.
- Larger loan amounts: The business’s financial needs will increase as the company grows. Small business lenders may offer higher loan amounts to meet those increased needs.
Disadvantages of a Business Loan
- More difficult to qualify for: Applicants must provide extensive documentation like a business plan, tax returns and recent financial statements. They must typically also have strong business and personal credit. If the applicant hasn’t been in business very long, their company may not meet the lender’s requirements yet.
- Rarely available for new businesses: Many business lenders require that a company be profitable for a certain amount of time before approving the loan.
The bottom line
Deciding whether to take out a personal or a business loan depends on the borrower’s needs and the requirements of the loan. For any loan, it’s important to shop around. Interest rates can vary between lenders, and applicants should carefully compare the fees, terms and total cost of the loan as well.
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