When it comes to financing a business, entrepreneurs often consider various options to ensure their ventures’ success. While business loans might seem like the obvious choice, there’s a financial tool that’s sometimes overlooked: personal loans. In this guide, we’ll explore the possibility of using personal loans for business purposes.
Redefining Personal Loans
Personal loans have long been associated with covering personal expenses, from weddings to home renovations. However, what many entrepreneurs don’t realize is that personal loans can serve as a financial resource for businesses as well.
While business loans are often the common choice, personal loans may hold unique advantages for startups and businesses with specific financial needs.
In the sections that follow, we’ll discuss the details of using personal loans for business expenses, eligibility criteria, the pros and cons of this approach, and alternative funding options.
Using Personal Loans for Business
Now that we’ve established that personal loans can be a viable option for business financing, let’s take a closer look at how entrepreneurs can leverage personal loans to cover various business expenses.
Personal loans can be employed to address a wide range of business-related costs, including but not limited to:
- Startup Capital: If you’re launching a new business, personal loans can provide the initial capital required to get your venture off the ground. This can include expenses for product development, marketing, and early operational costs.
- Equipment and Inventory: Personal loans can be used to purchase essential equipment or build up your inventory, ensuring your business has the necessary tools and products to grow.
- Operating Expenses: Whether it’s rent, utilities, salaries, or day-to-day operational costs, personal loans can help bridge gaps in cash flow, especially during the early stages of your business.
- Marketing and Advertising: Building brand awareness and reaching your target audience is crucial for any business. Personal loans can be invested in marketing and advertising campaigns to promote your products or services.
However, it’s important to note that some lenders may place restrictions on how personal loans can be used for business purposes. Before proceeding, do your research on whether your lender allows you to use personal loan funds for business expenses.
Eligibility and Credit Score
Each lender has their criteria that need to be met to be eligible to take out a personal loan. The primary factor that is often looked at when determining approval is a person’s credit score.
When it comes to credit score requirements, personal loans and business loans have distinct considerations.
Personal loans are primarily based on your personal creditworthiness. While some lenders may set a minimum credit score requirement of around 610, it’s often possible to secure a personal loan with a bad credit score. For instance, lenders like Upgrade and Avant may approve loan applications from individuals with credit scores as low as 580.
Business loans, on the other hand, have varied requirements that may start in the mid-500s. However, if you aim for the best approval odds and lower interest rates, you should ideally have a minimum credit score in the 700s.
Business loans tend to be more strict in their credit score requirements because there is a greater risk that the funds will be used ineffectively. Business is risky and lenders are taking on that risk when they approve business loans.
Pros of Using Personal Loans for Business
While using personal loans for business may not always be the first choice, they offer several benefits that can make them a great option in certain situations.
1. Lenient Lending Requirements
Personal loans typically come with more lenient lending requirements compared to business loans. When applying for a personal loan, lenders primarily focus on your personal creditworthiness. This means they are less concerned about your business’s financial history or your prior experience in the industry. This leniency can be especially helpful for startups and entrepreneurs entering a new field.
2. No Collateral Required
Most personal loans are unsecured, meaning they don’t require collateral. In contrast, securing an unsecured business loan can be challenging. This lack of collateral means you won’t have to risk your personal assets, such as your home or car, to secure the loan.
3. Fast Funding
Many personal loan lenders offer quick funding, with some even providing same-day funding options. This quick access to funds can be invaluable when you need to address urgent business expenses and can be used as emergency loans for rent, for example. Business loans, on the other hand, may involve a more extended application and approval process.
4. Reasonable Repayment Terms
Personal loans often come with reasonable and flexible repayment terms. These terms can span from two to ten years, allowing you to choose a repayment schedule that aligns with your business’s cash flow and financial goals.
5. Accessibility for Specific Business Situations
Personal loans are particularly accessible in specific business situations, such as:
- New Businesses: If you’re launching a new business, you may not have an extensive financial history or business credit. Personal loans can fill this gap, providing you with the funds needed to get started.
- Limited Industry Experience: In industries where you have little prior experience, business lenders may be hesitant to extend financing. Personal loans, however, primarily consider your personal creditworthiness, making them a more viable option.
Cons of Using Personal Loans for Business
While personal loans offer advantages for business financing, it’s essential to be aware of their limitations and potential downsides. Here are some of the cons associated with using personal loans for business purposes:
1. Low Borrowing Limits
One of the significant drawbacks of personal loans for business is their relatively low borrowing limits. Personal loan amounts are typically capped at around $100,000, which may not be sufficient for covering substantial business expenses. In contrast, business loans can provide much higher borrowing limits, sometimes reaching up to $5 million or more.
2. High Interest Rates
Personal loans often come with higher interest rates compared to business loans. While personal loan interest rates can range from 6 percent to 36 percent, the average rate hovers around 11.29 percent. In contrast, business loans tend to have lower average interest rates, making them a more cost-effective option. As a result, financing your business with a personal loan may lead to higher interest costs over time.
3. No Impact on Business Credit
Using a personal loan for business expenses won’t impact your business credit history positively. Payment history for personal loans is associated with your personal credit score, not your business credit profile. This means that even if you make timely payments on your personal loan, it won’t contribute to building or improving your business’s creditworthiness.
4. Risk to Personal Credit Score
Late or missed payments on a personal loan can negatively affect your personal credit score. If you use a personal loan for your business and encounter financial difficulties, it could lead to credit score damage. A lower credit score can, in turn, hinder your ability to secure other types of personal credit, such as credit cards or auto loans.
How to Get a Personal Loan for Business
Securing a personal loan for business involves a straightforward application process, but it’s important to be prepared and understand the steps involved. Here’s a step-by-step guide on how to obtain a personal loan for your business needs:
1. Confirm Your Credit Score
Before applying for a personal loan, it’s crucial to know your credit score and how it may impact your loan approval, interest rates, and terms. Your credit score plays a significant role in the lender’s decision-making process. If your credit score is lower than desired, consider taking steps to improve it before applying for a loan. Alternatively, you can explore applying with a co-borrower who has a stronger credit history.
2. Prequalification for Personal Loans
Prequalification allows you to explore potential loan offers without affecting your credit score. Many lenders offer prequalification tools on their websites. Take advantage of these tools to compare loan types, interest rates, and terms across different lenders. This step helps you identify which lender and loan offer best match your business’s financial needs.
3. Submit Your Loan Application
Once you’ve compared lenders and loan offers, choose a lender and submit your loan application. Be prepared to provide necessary documentation for identity and income verification. Lenders typically require proof of identity, such as a driver’s license or passport, as well as recent paystubs to verify your income.
4. Review and Sign Loan Documents
Upon approval, carefully review the loan agreement and any accompanying documents. Ensure you understand the terms, interest rates, repayment schedule, and any associated fees. If everything aligns with your business’s needs and financial capabilities, proceed to sign the loan documents.
5. Receive Funds
After finalizing the loan documents, the lender will disburse the funds to your designated account. Many personal loan lenders offer same-day funding, allowing you to access the funds quickly and address your business expenses promptly.
Keep in mind that personal loans typically have shorter repayment terms, ranging from two to 10 years. It’s essential to create a repayment plan that aligns with your business’s cash flow and financial projections to ensure you can comfortably meet your loan obligations.
Alternatives to Personal Loans for Businesses
While personal loans can be a viable financing option for some businesses, it’s essential to explore alternative funding sources to ensure you choose the best fit for your specific financial needs and goals. Here are several alternatives to personal loans for businesses:
1. Business Loans
As we have mentioned many times in this article, business loans are specifically designed to address various business expenses, making them a popular choice for established companies. These loans can cover costs such as equipment purchases, real estate investments, inventory, and working capital. Some lenders offer business loans with flexible requirements, making them accessible to a wide range of businesses, including those with less-than-perfect repayment histories.
2. Business Credit Cards
Business credit cards function similarly to personal credit cards but are intended exclusively for business-related purchases. They offer a revolving credit line, allowing you to spend up to your credit limit and repay the borrowed amount over time. Business credit cards are particularly useful for managing day-to-day expenses and building your business credit score. They often do not require a formal business structure to apply.
Crowdfunding is an alternative financing method that allows businesses to raise capital through donations from a crowd of supporters. Platforms like GoFundMe and Indiegogo enable businesses to create online campaigns and collect monetary pledges, which can be used to launch a new business, fund a specific project, or develop a product. Crowdfunding options include donation-based and reward-based campaigns, with varying levels of financial commitment from backers.
4. SBA Loans
SBA (U.S. Small Business Administration) loans are government-backed loans designed to support small businesses. These loans come with favorable terms, including lower down payments and extended repayment periods of up to 25 years. There are different types of SBA loans, such as the 7(a) loan for general purposes, the 504 loan for real estate and equipment, and microloans for smaller needs (typically $50,000 or less).
5. Business Lines of Credit
Business lines of credit provide businesses with access to a predetermined amount of funds that can be used for various purposes. These lines of credit are ideal for managing short-term expenses and offer flexibility in borrowing and repaying. They can be secured or unsecured, and you only pay interest on the amount you utilize, which can make them cost-effective compared to traditional loans.
Pick the Option That Aligns With Your Business Goals
Businesses have the flexibility to use personal loans as a financing option, although they are primarily intended for personal expenses. While business loans are often the preferred choice due to their lower interest rates and higher borrowing limits, personal loans can be a viable solution for startups and businesses with specific financial needs.
When considering whether to use a personal loan for business purposes, it’s important to weigh the pros and cons. Personal loans offer lenient lending requirements, do not require collateral, provide fast funding, and offer reasonable repayment terms. They are particularly accessible for new businesses or those with limited prior experience.
However, personal loans also come with limitations, including lower borrowing limits, higher interest rates, no impact on business credit, and the potential risk of affecting your personal credit score negatively.
Before opting for a personal loan, it’s essential to explore alternative funding options, such as business loans, business credit cards, crowdfunding, SBA loans, business lines of credit, working capital loans, and equipment financing. Each of these alternatives has its advantages and disadvantages, making it important to align your choice with your specific business goals and financial requirements.
In the end, the key takeaway is to carefully consider all available financing options and choose the one that best suits your business’s unique needs and objectives. Making an informed decision will help ensure your business’s financial stability and growth.