Today more than ever, it’s easy to get approved for a business loan to provide your company with the cash flow it needs to get off the ground. But did you know that business loans aren’t your only option when it comes to securing the capital you need? An increasing number of entrepreneurs have taken out a personal loan for business expenses.
For many small business owners, personal loans carry advantages over traditional business loans that shouldn’t be overlooked if you want affordable access to capital.
Check out our guide below to find out whether a personal loan is the right option for your business, and how you can apply for one today.
Personal Loans vs. Business Loans: What You Need to Know
Before you consider applying for a personal loan to start a business, or to take your existing business to the next level, you need to know how they differ from regular business loans. Below, we’ve highlighted some of the main differences between them, as well as their respective advantages.
Business Loans 101
Business loans have the key benefit of limiting your personal liability. In other words, the loan is taken out by a legal entity that is distinct from you, and therefore you aren’t held as responsible for it as you would be with a personal loan. Further, your personal FICO score will usually remain unaffected by how your business loan is handled.
If you want to build a business credit score, taking out a loan in the business’s name is one of the best ways to accomplish this—assuming, of course, that you repay it on time. Repaying a business loan is one of the fastest methods of building a rock-solid business credit score with the major credit reporting agencies (i.e., Experian, TransUnion, Equifax).
Business cards tend to have higher credit limits and sometimes offer additional travel perks.
Personal Loans 101
Taking out personal business loans can be easier than a standard business loan since they have more lenient eligibility standards. For instance, business cards are notoriously difficult to obtain unless you have a business credit score (e.g., FICO SBSS) already established, or have a very high personal credit score (i.e., 700 or higher).
With a personal loan, the opportunity is there to dive right in and apply without having to fill out dense paperwork or extensive background checks. Therefore, taking the personal business loan route is the speedier option of the two.
However, if your credit score isn’t great you may have to personally guarantee the loan, which means you’ll be on the hook for putting up collateral and potentially having those assets taken if you default on the loan.
The downside to a personal loan is that they tend to have lower credit limits, higher interest rates, and may require collateral to secure the loan. As such, they are usually the more costly option if you’re deciding between a business loan or personal loan for business.
Know Your Score
Before you decide to start applying for either a business loan or personal loans for business activities, you should first know what your credit score is. Approximately 90 percent of America’s top lenders use FICO scores to gauge whether a prospective borrower is trustworthy.
It’s crucial that you keep your FICO credit score as high as possible.
Usually, your FICO score is the first thing that lenders look at when they review your personal loan application. To find out what your score is, input your personal information on one of the several online FICO score calculators, which retrieve their data from the top credit reporting agencies like TransUnion and Equifax.
Ideally, you will want to shoot for a FICO score in the 800 range. This is the top bracket, and scores in this range typically get approved without delay. However, you can still get approved for loans with bad credit or no credit history.
Below, we’ve outlined what each FICO score means so that you can get a better read on your score:
- Bad Credit: 300-569
- Fair Credit: 570-669
- Good Credit: 670-739
- Excellent Credit: 740-799
- Exceptional Credit: 800-850
The 300-850 credit scoring model is most commonly used to evaluate personal creditworthiness. However, if you decide to apply for a business loan instead, they will consider a separate business credit score which is typically rated on a one-to-100 scale, or a FICO SBSS score, which is specific to small businesses, and range between zero and 300.
When to Use a Personal Loan
Most of the time, business loans are superior to personal loans if you’re trying to finance your small business. However, they tend to be more exclusive than personal loans, in that the qualification standards are just a touch higher than small business personal loans. Here are three times using a personal loan for business might make sense.
1. You Don’t Qualify for Business Loans
Nearly three-quarters of small business owners do not qualify for small business loans, which means they have to turn to personal loans or other debt financing options to fund their venture. It makes sense, then, that so many business owners have been forced to turn to personal loans to secure financing.
After all, over 55 percent of alternative lenders approve personal loan applications—a major step up from the low business loan approval rates.
You should consider using a personal loan for small business financing whenever your business loan application gets turned down. Taking out a personal loan, although they have higher annual percentage rates (APRs), can rebuild your personal credit score to the point where, in the future, you may qualify for a standard business loan.
2. You Don’t Have Collateral
Many small businesses aren’t in a position where collateral can be used to secure a loan. Many business loans have lower interest rates and higher limits, which make them riskier for the creditor. This is why many creditors require business loans to be backed by collateral, which often consists of any of the following assets:
- Home equity
- Personal vehicles
- Accounts receivable (i.e., unpaid invoices)
The unfortunate reality for many entrepreneurs is that they simply do not have the assets laying around to offer as collateral. If this sounds like you, you can turn to unsecured personal loans to get approved for a loan without the need to put up collateral.
3. You Don’t Need to Borrow a Large Amount
Unless you’re taking out a microloan, business loans are generally offered in the six and seven-figure range. In most cases, these loans have long terms to the tune of a decade or longer, and, if left unchecked, can throw you into a never-ending debt spiral.
Fortunately, personal loans exist as small as $5,000, which can help provide you with the capital you need and not a penny more. Be warned, however, that these loans tend to carry significantly higher interest rates than regular business loans—this, of course, is to hedge against the risk of defaulting on an unsecured loan.
Is a Personal Loan Right for You?
When considering a personal loan, business owners need to weigh their options and play the field. They should ask for quotes from a variety of traditional and alternative lenders to see if they can qualify for a loan of the right size, at the right term length, at an affordable rate.
A personal loan for business use is often the best option when a business is brand new or hasn’t yet opened its doors. This is because lenders only care about your personal credentials and not your business’s when evaluating your application for a personal loan.
New businesses without a credit history are therefore more likely to get approved for a personal loan than a business loan.
Don’t let this discourage you from applying for a business loan. Usually, business loans are the better option of the two if you happen to qualify for them. Plus, keeping your personal and business finances separate will save you a world of hassle come tax season.
In most cases, using a personal loan for business is a matter of necessity. If you’re a new company that hasn’t yet established itself, a personal loan provides a great opportunity to rebuild your credit score, generate revenue, and get your business off the ground.
As your company develops, you should seek out business loans to separate your finances and start building a business credit history.