You want to finance your small business, and you aren’t sure which type of loan you need. It is natural to assume that a business loan is the right choice for your professional pursuits, but many business founders and entrepreneurs find that personal loans are also a viable option.
Before you decide, it is important to do thorough research to understand the pros and cons of business and personal loans and how each one will impact you and your business in the future. Read on to learn more about the requirements and consequences of each loan type and find out how they can support your business in the long run.
For people who like to keep their professional and personal lives separate, a business loan is a good way to distinguish that break. Not only does avoiding mixing your company’s funds with your personal account help prevent overspending or dipping into savings, but you will also reap greater rewards come tax season.
These types of loans might also offer an added level of protection when it comes to personal liability. Any business owner knows to “expect the unexpected.” Being proactive and choosing a loan that isn’t directly tied to your personal funds may reduce the consequences of a default or other financial difficulties in the future.
Personal loans are easier to obtain than business loans, so people with small companies or startups tend to favor this option. Typically, a personal loan requires applying to a lender, getting a credit check, and then receiving either an approval or a rejection. The acceptance is almost entirely contingent upon your personal credit score, so if you happen to be in good standing, chances are you’ll be able to get the loan you need without much hassle. Many personal loans are also unsecured, which means you won’t have to offer any collateral to get your money.
Of course, personal loans are, well, more personal. The risk you take when you borrow a personal loan for your business is much larger because any financial struggles or even default has the potential to ruin your own credit. You also don’t get the opportunity to build your firm’s credit by choosing a personal loan. This means that this loan type might not be a good choice if you want to pursue additional financing services in the future as your business expands.
When you apply for a loan in your own name, only your personal information is relevant to the lender. Your company’s success (or need for help) won’t impact your approval or rejection rate. If you’re currently in a tight spot and you need fast money to put things back on track, a personal loan may be a good option because you can often obtain one more quickly and more easily than a business-type of loan.
Finding a good personal loan lender takes time and research, but the faster application process is a plus. Some people even borrow personal loans from family and friends. Your options are broader when it comes to personal loans, but you can almost always expect higher interest rates and lower limits.
Business lenders, on the other hand, have a lot at stake. When a lender offers you a loan for your business, they’re making an investment in you and your enterprise. They don’t want to give money to any company they don’t believe in or that doesn’t have verifiable proof of past success and projected growth.
To get a loan for your business, you have to provide a slew of financial documents. You will have to show proof of your business’s credit, a detailed business plan that demonstrates how the loan will be applied (and return a profit), and other records to confirm your business’s legitimacy.
Small companies need cash flow to grow, and a small business loan is designed to stimulate growth and keep a business in good standing. It’s not uncommon for small business owners to find that there is an uneven balance between profit and expenses. Even if you can project that things will turn around in your favor, cash only goes so far, and you have to make sure all your business’s financial obligations are met if you want to succeed.
There are many types of small business loans that can help you resolve any current financial difficulties that will prevent you from continuing to grow in the future. Even if you happened to save up and start your business with your own money, every company should incorporate how to obtain a loan into their business strategy.
Many startups that experience rapid growth are shocked to find how massively their expenses increase seemingly overnight. In order to reduce the risk of running into a problem down the line, loan planning and consideration should be implemented into the business model before troubles arise.
You can get small business loans for many reasons, but it’s important to evaluate how they can affect your company in the long run. If you are applying for a loan to expand your property or make large-scale renovations that will increase profits, then a business loan might be a good idea. This type of loan is also a good solution for those looking to purchase machinery and equipment that will be used for many years to come.
For smaller purchases, other funding options may work better. For example, if you’re using a loan to make minor changes or cosmetic upgrades or simply implement new software or equipment that will have to be updated or replaced within the next five years, a loan might actually cost more than it’s worth.
Consider whether the loan’s use will be long term or short term. Also, it’s important to think of a small business loan as your own investment into your company. Make sure that you have a set purpose in mind before you borrow any money. The repayment period shouldn’t outlast the loan’s purpose and effect on your business.
The Small Business Administration (SBA) provides guarantees on low-cost loans that lenders loan to small business owners. It’s easier for many people to qualify for an SBA loan than traditional bank loans.
SBA long-term loans are funded directly by a bank or lender, but the SBA guarantees part of the amount. This means that if a borrower defaults or cannot repay their loan, the SBA will automatically cover a portion and repay the lender.
Because of this security, people find it easier to obtain a loan through the SBA than a private lender or bank. However, this means that borrowers must offer their own form of security to the SBA.
Depending on the type of loan, a small down payment, as well as some collateral, will have to be offered in exchange for loan financing. The thought of wagering part of your business on a loan might make you apprehensive, but this measure ensures people who are taking out a loan have the intention to pay it back.
You may wonder whether a personal loan is a better option for your small business. If you’re just getting started, it’s understandable why you might prefer to go this route. In many cases, people want to take out a loan in their own name to establish a new business or grow one that has just started.
For freshly minted entrepreneurs, obtaining a small loan for your business without any demonstrable track record can be next to impossible. A personal loan offers the opportunity to acquire a large sum of money that will, if strategically implemented, repay itself.
Each type of loan has its own requirements. In general, you can expect your credit score to play a large factor in your approval. You should check your credit at least once a year. Credit is rated on a scale between 300 and 850. Anything over 700 is considered “good,” and anything over 800 is considered “excellent.”
Credit scores are an indicator of your financial standing and responsibility to lenders and banks. Most personal loans have a minimum credit score requirement of 640-750. Your income is also an important factor when it comes to personal loans.
Most lenders will not allow you to exceed a 45-percent debt-to-income ratio (DTI). Your DTI is your monthly debt payments divided by your gross monthly income. Those who have a higher DTI are more likely to struggle with paying back their debts, so lenders put a cap on how much someone can borrow based off their gross monthly income.
Business loans require more than just a good personal credit score and verifiable proof of income; you’ll also have to demonstrate a current picture of your business’s financial standing as well as its history thus far. Private lenders will each have their own requirements, but you can expect that your personal credit score will also influence the lender’s choice.
A business loan is a good investment if you have the money and ability to demonstrate both your company’s and your own financial capability. A business loan is ideal for someone who wants to buy commercial property, purchase expensive equipment, or make significant upgrades that will greatly impact the business’s financial future.
Generally, lenders won’t offer a business loan to people who aren’t in good financial standing already. A business loan is designed to enhance and evolve a company rather than save it from ruin.
You’ll typically have to offer a down payment and some type of collateral to secure a business loan. The repayment periods are longer, and interest rates are generally lower than they are with personal financing.
Personal loans are a better solution for those who might be using the money to get their business off the ground or resolve a financial problem. If you have the right connections, a loan from a family member or friend can spare you having to apply to multiple lenders. If you do decide to go the lender route for a larger sum of money, expect your credit score and income to influence how much you can borrow.
Ultimately, a loan isn’t a way to escape financial ruin. If you are only using it to get by for a month, it’s better to consider the long-term future of your operation. Rather than relying on a loan to keep your business up and running, be sure to evaluate your current strategy. When you have a strong plan for the future, a loan can be used to grow your business rather than keep it standing still.
Chris Fuller went to the University of South Florida and has worked in the financial sector for over 20 years. He has extensive experience in all aspects of personal and small business lending, from personal loans, equipment finance to cash flow based solutions for small mom and pop businesses, and large corporations.