The difference between a business loan vs. a personal loan for small business is that a business loan is specifically designed for business purposes and offers higher borrowing amounts and tax-deductible interest. In contrast, personal loans are more versatile and require fewer requirements.
Many business owners need funding to run and grow their businesses. In fact, approximately 37% of small businesses applied for a loan in 2021.1 But what type of loan is right for you?
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 installment loans are a commercial financing option for eligible entrepreneurs to grow or run their businesses. The average small business loan amount is approximately $663,000.1
Potential borrowers can obtain one of these installment loans 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. Can be risky for the borrower because they lose their collateral if they default on the loan.
- Unsecured Loans — Does not require collateral, which means lenders may have stricter qualification requirements that depend.
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.
Documents Required for Business Loans
When applying for a business loan, lenders typically require a range of documents to assess your business’s financial health and the risk involved in lending to you.
Here’s a list of common documents you might need:
- Business Plan — A detailed plan outlining your business model, market analysis, product or service offerings, management team, and financial projections. This helps lenders understand your business strategy and growth potential.
- Proof of Business Registration and Licenses — Documents that verify your business is legally registered and compliant with local, state, and federal regulations. This includes your business license, articles of incorporation, and any other relevant permits.
- Financial Statements — This includes your balance sheet, income statement, and cash flow statements. These documents provide a snapshot of your business’s financial health and performance.
- Bank Statements — Recent business bank statements (typically the last six months to a year) to show your business’s financial activity and cash flow.
- Tax Returns — Both personal and business tax returns for the past few years. This helps lenders assess your business’s profitability and your personal financial involvement in the business.
- Credit Score Reports — Your business credit and personal FICO score (especially important for small business owners). A good credit score can increase your chances of loan approval and better loan terms.
- Collateral Documentation — If you’re applying for a secured loan, you’ll need to provide documentation of the collateral you’re offering, such as real estate or equipment.
- Debt Schedule — A comprehensive list of any outstanding debts or loans your business currently has, including details like amounts, lenders, and repayment terms.
- Legal Documents — Depending on your business structure and industry, you may need to provide additional legal documents, such as franchise agreements, commercial leases, or any contracts with significant clients.
- Owner’s Personal Information — This includes personal identification, such as a driver’s license or passport, especially for small businesses where personal and business finances are closely linked.
Finding the Best Business Loan Lender
You can get a business loan from a few different types of lenders. The best option will vary depending on your financial situation and background.
- Traditional banks are a primary source for business installment loans. They offer a variety of loan products, including term loans, lines of credit, and SBA loans.
- Examples: JPMorgan Chase, Bank of America, Wells Fargo.
- Non-profit organizations that often provide lower interest rates than banks. Membership is required, which can be based on location, employment, or other affiliations. Members typically pay a monthly fee.
- Examples: Navy Federal Credit Union, Alliant Credit Union.
- Online lenders offer quick application and approval processes, which makes them ideal for businesses that may not qualify for traditional bank loans.
- Examples: OnDeck, Kabbage, LendingClub.
Small Business Administration (SBA)
- Offers small business loans with favorable terms through partner lenders. Includes popular programs like 7(a) loans, 504 loans, and microloans. The SBA is not a direct lender but they guarantee a portion of business loans.
Peer-to-Peer Lending Platforms
- Connects businesses with individual investors willing to front funds for business and other expenses. However, there is no guarantee that you will get funding.
- Examples: Funding Circle, Prosper.
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 installment 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 installment loans can also help you grow credit for your business. An established history of business loans 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 start a business without good credit, know that you may not get a considerable loan amount.
When your credit history is short or nonexistent, 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 Installment 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 credit score for your business. 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
Loan Amount Varies
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.
Can’t Grow Business Credit
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 credit score for your business can help you obtain enough capital to afford further growth.
Business Loan vs. Personal Loan: Which Is Better?
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.
|Aspect||Business Loans||Personal Loans|
|Purpose||Specifically for business-related expenses like equipment, expansion, inventory.||More flexible, can be used for a variety of personal or business expenses.|
|Loan Amounts||Generally higher, suitable for significant business investments.||Typically lower in comparison, aimed at personal or smaller-scale expenses.|
|Interest Rates||Often lower, but depends on business credit and financial health.||Can be higher than business loans, but varies based on personal credit score.|
|Repayment Terms||Longer terms are common, tailored to business needs and cash flow.||Usually shorter than business loans, but varies by lender and loan amount.|
|Eligibility Criteria||Business credit, business plan, financial statements, revenue, and history.||Personal credit, income, employment history, debt-to-income ratio.|
|Collateral||Often required, especially for larger loans.||Typically unsecured, but secured options are available.|
|Tax Benefits||Interest paid is often tax-deductible.||Personal loan interest is not typically tax-deductible.|
|Approval Process||More rigorous, requires thorough business evaluation.||Generally quicker, focuses on personal credit and income.|
|Impact on Credit Score||Affects business credit score.||Affects personal credit.|
|Flexibility in Use||Must be used for business purposes.||Highly flexible in terms of usage.|
Frequently Asked Questions About Personal and Small Business Loans
Generally, business loans typically have lower interest rates compared to personal loans, but this can vary based on your personal credit and the lender.
Repayment terms can vary widely, but business loans often offer longer terms compared to personal loans. However, this can depend on the lender and your specific financial situation.
Yes, interest paid on business loans is often tax-deductible. However, it’s best to consult with a tax professional for your specific circumstances.
Typically, business loans offer higher borrowing limits than personal loans, especially for established businesses with a solid financial history.
Competitive rates for both personal loans and small business loans can be found through various online lenders and banks. It’s always a good idea to shop around and compare offers.
The approval process for business loans usually involves more scrutiny of your business finances and plan, whereas personal loans tend to focus more on your personal credit score and income.
Yes, many online lenders and credit unions offer both personal loans and business loans without the need for a guarantor, especially if you have a strong credit history.
A personal loan for business can be used for various expenses, but it’s important to check with the lender about any restrictions on using personal loan funds for business purposes.
Yes, personal loans tend to offer more flexibility in how you can use the loan funds, whereas business loans typically have more specific requirements related to business expenses.
For more detailed information, you can explore financial websites, consult with financial advisors, or contact various online lenders and credit unions to understand the best option for your specific needs.
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