Starting a new business requires a good idea, customers to whom you can sell your product or service, and money to get you off the ground. A personal loan to start a business can be one option for funding, especially if you don’t yet qualify for a small business loan or you qualify for a personal loan with a low interest rate. Here’s a look at the pros and cons of using a personal business loan to start your business as well as some alternatives to look into.
What Is a Personal Business Loan?
Personal loans to start a business are offered by some banks, credit unions, and online lenders. The borrowed funds are paid back with interest in regular monthly installments. While most loans will specify what you can spend the money on — a mortgage must be used to buy a house, for example — the sum you receive from a personal business loan can be spent in a variety of ways. It’s important to check with your lender about whether their personal loans can be used for business expenses, as some lenders do not allow it.
Your personal loan interest rate is based on a combination of financial factors, including financial history, income, and credit score. Generally speaking, the higher a person’s credit score, the more likely they are to receive a personal loan with favorable terms and interest rates. Applicants with lower credit scores may find it more difficult to qualify for low-interest rates. That’s because lenders tend to see them as at greater risk of defaulting on their payments and, to offset that risk, they might charge a higher interest rate.
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Why Might You Use a Personal Loan to Start a Business?
Personal loans for business may present a number of benefits compared to some other alternatives.
Ease of Qualification
Banks offer personal business loans based on personal income and credit score. On the other hand, when you apply for a business loan, you’ll likely be asked for quite a bit of information during the application process, including your personal and business credit score, annual business revenue and monthly profits, and how long you’ve been in business. The longer your business has existed, the more likely you are to have a record of revenue and profit, and the more likely you are to qualify.
If your business is brand new, it can be tricky to get a business loan right off the bat, and it may be easier to qualify for a personal loan.
How long it takes to get approved for a personal loan and receive funding will vary by lender. Online lenders are typically faster than banks and credit unions. However, you are likely to receive funding within seven business days.
By contrast, the process for a business loan can be much slower. For example, it can take 60 to 90 days to receive funding from a Small Business Administration (SBA) loan.
Can Have Low Interest Rates
Personal loan applicants with a positive credit history and a healthy credit score may be able to qualify for a low interest rate. In general, interest rates on personal loans can be much more competitive than those on other types of credit.
Credit cards, for instance — although not an inherently bad choice for business credit — can have higher interest rates than other types of lending options. They may also have penalties and fees that personal loans may not have, such as penalty annual percentage rates (APRs) that go into effect if you make a late payment, over-limit fees if you spend more than your credit limit, annual fees, and more.
Flexibility and Versatility
Personal loans have few restrictions on how you’re allowed to use the money you borrow. That means you can spend on anything from buying or renting a building to marketing materials to purchasing inventory, as long as your lender doesn’t restrict the personal loan funds to non-business purposes.
What Are Some Risks of Using a Personal Loan to Start a Business?
Despite the potential advantages of using a personal loan to help you start your business, there are also potential drawbacks to consider.
Some Lenders Don’t Allow Personal Loans for Business
Some lenders do place certain restrictions on how you spend your personal loan. Being upfront about your intentions to use it for business expenses and asking if that is allowed is a good idea. In some cases, it may not be. However, it’s far better to be honest about how you plan to use a loan than risk breaching the loan agreement. If you end up using a loan in a prohibited way, your lender could force you to repay the full amount of the loan with interest.
Can Mean a Smaller Loan
Personal loans generally offer borrowing limits as low as $1,000 and as high as $100,000 for larger personal loans. For small businesses, this might be plenty. But if you’re a larger business that needs more money, you may be better off looking for a loan that can better meet a business’ financial needs.
Can Have Shorter Repayment Terms
Lending periods for personal loans will vary. Typically you can find loans with term lengths of 12 months to five years, sometimes a bit longer. When compared to some small business loans, this is a relatively short period of time. Consider that for SBA loans, maximum terms can be as much as 25 years for real estate, 10 years for equipment, and 10 years for working capital or inventory.
Personal Credit Score and Assets Could be Affected
If you take out a personal loan and are unable to make monthly payments, you are putting your personal credit at risk. Missed payments may have a negative effect on your credit score, which can make it more difficult for you to access funding in the future.
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May Qualify for Fewer Tax Deductions
In general, the interest you pay on a personal loan is not tax deductible. However, it may be if you use it for business purposes. This can get a bit tricky. You may only deduct interest on the portion of the loan that is used for business expenses. So if you use any of that money to remodel the bathroom in your home, for example, interest on that portion can’t be deducted.
Businesses are able to deduct interest from bank loans, vehicle loans, credit card debt, and lines of credit.
Personal Business Loans vs Small Business Loans
Borrowing money to pay for business expenses is a decision that takes some consideration. There are different reasons you might want or need a business loan, there are many lenders to choose from, and there are different lending options to compare. Here are some things to think about if choosing between a personal loan for business or a small business loan.
|Factor to Consider||Personal Loan for Business||Small Business Loan|
|Use of funds||Some lenders may not allow personal loan funds to be used for business purposes||Specifically for business purposes — cannot be used for personal use|
|Qualification||Personal creditworthiness determines approval, interest rate, and loan terms||Lenders will require business financials, proof of time in business, and other details, in addition to possibly taking personal credit into account|
|Interest rate||Depending on your creditworthiness, interest rate may be lower than other forms of credit, such as credit cards||Depending on the type of loan, interest rates on SBA loans may be lower than some personal loans|
|Loan amount||Up to $100,000 depending on the lender.||SBA maximum loan amount is $5 million.
Some lenders may approve working capital loans for up to several million dollars
|Funding time||Depending on the lender, loan funds may be disbursed as soon as the day of approval or in up to seven days||The SBA loan timeline is between 60 and 90 days from application to disbursement.
A working capital loan from a traditional lender may be approved quickly and funded shortly after approval
|Tax deductibility||Interest is not generally tax deductible||Interest may be tax deductible in some cases|
Alternatives to Personal Business Loans
Personal loans may not be the best option for everyone and are not the only way you can fund your small business. You may also want to consider small business loans or a business line of credit.
Small Business Loans
Small business loans are offered through online lenders, banks, and credit unions. There are a variety to choose from that may be designed for specific purposes. For example, a working capital loan is designed to help you finance the day-to-day operations of your business. An equipment loan can help you replace aging technology and buy new equipment.
SBA loans are guaranteed by the Small Business Administration, whose aim is to help small businesses get off the ground and grow. That means if you aren’t able to make your payments, the SBA will step in and cover 85% of the default loss. By reducing risk in this way, the organization helps businesses get easier access to capital.
Shopping around for the best small business loan rates is a good way to compare lenders and find the one that works best for your unique financial needs.
Business Lines of Credit
A business line of credit is revolving credit, much like a credit card. You are allowed to borrow up to a certain amount and you only pay interest on the amount you are currently borrowing, making this option more economical than a term loan for some business owners. As you repay the funds, the amount of credit available to you reverts back to the original limit and you can borrow the money again.
Another advantage to a line of credit over a term loan is the ability to use a check to pay vendors who may not accept credit cards.
Credit cards, with a current average interest rate of more than 16%, tend to have higher interest rates than other types of funding. For example, the average finance rate for personal loans is about 9.41%, according to the Federal Reserve.
Also, credit cards are revolving credit. If you don’t pay off the balance each month, you can fall deeper into debt. Whereas, installment loans offer fixed monthly payments with a fixed end date.
Business credit cards may be a good choice for some business owners, though, to keep personal and business expenses separate. They may also offer rewards, perks, and bonuses that make them an attractive option.
Recommended: Breaking Down the Different Types of Credit Cards
Merchant Cash Advance
Funding for a merchant cash advance (MCA) is based on a business’ past credit card receipts. Technically not a loan, an MCA is an advance on future revenue. The business repays the MCA lender a percentage of its monthly sales revenue until the debt is paid in full.
Taking out a personal loan is one way to fund your small business needs, as long as your lender allows the funds to be used for business expenses. There are alternatives, though, including lines of credit and SBA loans.
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