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19 Sep 2018

Personal Loans vs Business Loans: Which Should You Use to Fund Your Business?

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When looking at the names personal loan and business loan it might seem obvious which one you should be used to fund your business. But believe it or not, both options can be used to fund a startup. It’s just a matter of which one will work best for you.

If you’re not sure how these funding options work, just keep reading. In this article, we’ll make all the complexities of personal and business loans as simple as possible. While also giving you the pros and cons of each.

What Are Personal Loans?

Personal loans are available through credit unions, banks, and online lenders. They are usually unsecured debts which means they aren’t backed by collateral like your house or bonds.

Because the lender won’t be able to take property if you don’t meet their payment terms, they go through extra measures to make sure you can pay the debt. For instance, they will take things into account like:

  • Your salary
  • Debt to income ratio
  • Whether you have a cosigner
  • Credit score
  • Payment history

You are usually given 2-5 years to pay a personal loan off. This is a perfect window of time to allow your business to get off the ground and generate revenue.

The interest rates can sometimes be as high as 36% with 7% being the lowest. Like some other loans, the interest rate here depends on the factors listed above.

Pros of Using Personal Loans to Start a Business

From a paperwork standpoint, personal loans are easier to secure and require less input than a business loan would. For instance, you won’t need to provide a business plan, financial records, and other business information that you may not have available when applying for a business loan.

Another plus is you don’t need collateral which can hold you back from obtaining a business loan even if all your other paperwork pans out. Additionally, personal loans are all-purpose loans that can be used for anything. But when you obtain a business loan, the money will sometimes have to be delegated in a particular way.

Cons of Using Personal Loans to Start a Business

The biggest con to using a personal loan to start your business is that these loans are known to have high interest rates. This, of course, means you will have to make more expensive payments on the loan which can take away from your business profits.

Profits are extremely crucial at the start of your business when you might not be bringing in a lot of revenue just yet.

Another con to starting your business with a personal loan is that it doesn’t allow your business to build its own credit, which will be important if you need something like a business credit card in the future.

What is a Business Loan?

There are different types of business loans to choose depending on your business needs. Each type of business loan has different terms and rules for qualification.

Here are some of the most common types:

Term Loan

A term loan is a standard commercial loan. They are typically used for purchasing fixed assets that help a business operate. An example of such an asset is a factory where your products are created.

Your business will have to be in operation for at least one year to qualify for a term loan. The business will also need to make at least $90,000 each year and have a credit score over 600 points.

To apply for this loan, here are some of the things you’ll need:

  • Business bank statements
  • Business tax returns
  • Personal tax returns
  • A voided business check
  • Profit and loss statements

These loans usually have a floating interest rate which is also called a variable interest rate.

Short-Term Loan

Short-term loans are a little easier to acquire. You need a credit score of at least 550 points and a minimum of $50,000 in annual revenue. Like the term business loan, you will have to have been in business for a year or more to qualify.

This is some of the paperwork you will need to apply:

  • Proof of ownership
  • Credit score
  • Business bank statements
  • Personal tax records
  • Voided business check

These tend to be high-cost loans with higher than normal interest rates.

Equipment Financing

To qualify for equipment financing, you need a credit score of 600 or more and 100,000 in annual revenue. You will also have to operate your business for at least 11 months.

A lender will ask for the following paperwork during the application process:

  • Business tax returns
  • An equipment quote
  • Bank statements
  • A voided business check

Depending on the type of business you’re running, an equipment finance loan is used for everything from a restaurant oven to a car.

Pros of Using a Business Loan

It’s smartest to keep your business and personal finances separate, especially when it’s time to deal with your taxes. When you secure a business loan, you’re making it easier on yourself and anyone who might do some accounting work for you to stay organized.

Using a loan that’s specifically for business will also eliminate your personal liability should something go askew. This is also an easy way for your business to begin building credit outside of your personal credit. This will help you borrow money for expansions and other business goals you might have.

Cons of Using a Business Loan

Business loans aren’t ideal for new business owners who are just starting out, although they tend to be the people who need them the most. Instead, most business loans require you to have at least one year of verifiable operations and revenue under your belt.

Additionally, applying for these loans is a tedious process that takes a lot of time. So, if you need one in order to make a fairly quick purchase to help your business grow, you can miss out on an opportunity while waiting for a decision to be made.

We Can Help

Bottom line: Personal loans are best used when you are in the beginning stages of establishing your business. While business loans can help an already established business reach new goals that take its growth to the next level.

We’re here to help you reach your financial goals in both your personal life and your business life. Continue to follow our blog and check out our learning center for more informative articles and finance tips.