Running a small business requires a lot of capital. You may consider applying for a business loan if you need a little financial support for business expenses. But many small businesses opt for personal loans instead. When considering the choice between a business loan vs. personal loan, it’s essential to understand the differences.
How Do Business Loans Work?
When a small business owner requires money for equipment, marketing expenses, new hires, etc. they can apply for a business loan. Business loans are a commercial financing option for eligible entrepreneurs to grow or run their businesses.
Qualifying for a business loan depends on a few requirements. Business lenders will typically consider the following factors:
- Your credit score
- Annual revenue
- Time in business
- Business plan
- Debt ratio
Some business lenders will also require a personal guarantee in case of default. If you fall behind on payments, you must repay the business loan using personal funds.
Every business lender will require a minimum annual revenue, but the range will vary. If you receive business loan approval, you will receive your money through a lump sum that you can repay daily, weekly, or monthly.
Potential borrowers can obtain a business loan at a bank or credit union. Although, there are plenty of online lenders that provide business loans as well. Business loan financing can be secured or unsecured. Secured loans require collateral, such as equipment or real estate. Using collateral to secure funding can help you get approval if you have a new business. However, the lender can seize your collateral if you fall behind on payments.
Pros and Cons of Business Loans
If you are a small business owner, a business loan could help you afford startup costs, real estate remodeling, shipping supplies, etc. If you are considering applying for a business loan, first learn the pros and cons.
Pros of Business Loans
Larger Loan Amounts
Business loans offer a lot more money than personal loans. You could get thousands of dollars to afford high-cost expenses if you have an excellent personal credit score. A sizable small business loan can help you start a business from the ground up!
Separate Personal and Business Finances
Small business loans are beneficial because they help separate your personal and business finances. Keeping business and personal finances separate can limit your personal liability in the event your business defaults or has financial difficulties.
Build Business Credit
Taking out business loans can also help you grow your business credit score. An established business credit history can help you obtain larger loans in the future when you want to expand your business.
Cons of Business Loans
Suppose you currently run a profitable small business. That may not be enough to qualify for a small business loan. You may find it difficult to get loan offers from business lenders if your small business does not have an established credit history. And if you want to open a business with less than perfect credit, know that you may not get a considerable loan amount.
When your business credit history is short or nonexistent, business lenders will use your personal credit history and require a personal guarantee. A business loan can affect personal credit if you default on the loan.
The approval process to get a small business loan can be exhausting. You may have to apply for a different loan option if you need money now. It can take days for a business lender to verify your information and disperse your money.
How Do Personal Loans Work?
Personal loans are convenient because borrowers can use their loan money for personal expenses. If you want to use a personal loan for business purposes, verify your spending intentions with the lender, as some financial institutions have spending restrictions.
Personal loans provide borrowers with a lump sum they can pay off monthly. Borrowers can choose how long they want to pay off the personal loan. Suppose you need a large personal loan to temporarily cover rent or payroll costs. In that case, you can keep your monthly payments small by opting for an extended repayment length.
Qualifying for a personal loan depends on your personal credit history and income. When conducting a credit check, personal loan lenders will review your debt to income ratio, existing accounts, and payment history.
Personal loans are typically unsecured, but you could find a lender that accepts personal assets as collateral. Using collateral can help individuals with a bad personal credit score get approval and a more considerable loan amount.
Pros and Cons of Personal Loans
Personal loans can help small businesses afford necessary expenses to keep their doors open. There are a lot of advantages to personal loans. Still, there are cons to consider before deciding between a business loan vs. personal loan.
Pros of Personal Loans
Flexible Approval Requirements
Many small business owners use personal loans for business expenses because the qualification requirements are more flexible. Personal loans are an ideal option if you want to get a loan with no credit. Approval for a small business loan depends on your personal and business credit history. Whereas personal loan lenders only focus on your personal credit history.
The approval process for business loans can be a hassle, especially if you do not yet have a business credit score. Personal loans are ideal if you need money quickly to meet payment deadlines. Eligible borrowers can get cash in their bank account within one business day!
No Collateral Required
Personal loans typically do not require collateral, even if your credit score is low. Business loans require either a personal guarantee or collateral for bad or unestablished credit. Collateral lowers the lending risk for lenders, which can help borrowers with poor credit obtain better loan terms. But suppose you experience financial issues during the repayment process and fall behind on payments. In that case, you risk damaging your credit score and losing personal assets.
Cons of Personal Loans
A personal loan for business expenses can help you obtain money quickly despite a bad or unestablished credit score. However, you may not receive a substantial loan amount. You may have to consider other financial options if you need more than a few thousand dollars.
Personal loan interest rates can be higher than business loans if borrowers don’t research lenders thoroughly. Before signing any loan agreements, it’s essential to consider the interest rate since it is equivalent to the cost of borrowing. Borrowers can struggle to keep up with payments when interest rates are too high.
Using a personal loan to afford business costs can prevent your business from growing a credit history. When your small business has a paper trail of financial activity, you have more financial opportunities available. Down the line, a business credit score can help you obtain enough capital to afford further growth.
Business Loan vs. Personal Loan: Which Is Better?
When trying to run a small business, there are a lot of financial aspects to consider. Most business owners consider applying for a business loan as they need money for a business. But a personal loan is a great alternative solution for business expenses. So when it comes to a business loan vs. personal loan, which is the better option?
The answer depends on how much money you need, your financial history, and your business plans for the future. Qualification for either loan option depends on either your personal credit history or business credit. Lenders may expect you to provide collateral with business loans if your credit has a bad credit score or thin credit file. Are you willing to risk losing a high-value asset in case of financial hardship?
Many entrepreneurs do not consider using poor credit installment loans for business purposes. But many personal loan lenders do not have spending restrictions! You could use your borrowed money to afford all kinds of business costs.
In truth, there is no clear-cut answer to the question, “Which loan option is best for you?” The best way to narrow down your options is to make comparisons. Knowing what you expect from a loan agreement can help you make a confident financial decision.
How Do Business Loans Work?