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Business loan vs personal loan: what’s the difference

personal loan vs business loan

The key differences between a business loan vs. a personal loan is how the funds can be used and the qualification requirements. Business loans can only be used for business expenses, while personal loans can be used for almost any expense. Business loans tend to have stricter qualifications. Aside from these major differences, you’ll find that personal loans and business loans actually have some things in common. Below you will find everything you need to know about business loans vs. personal loans. 

Funding For a Small Business

There are multiple options available for financing a small business. The most obvious choice being small business loans, also simply referred to as business loans, is what most people’s minds immediately jump to. However, personal loan options are widely used for business purposes and might be the better option than small business loans for some. 

Whether personal loans or small business loans are suitable for your financing needs depends on your priorities and circumstances. Before settling on one over the other, it is important to understand how each lending product functions as well as the benefits and drawbacks of each. 

Personal Loans Vs. Business Loans

Business loans can be an obvious choice for small business financing needs, but personal loans can be used for business purposes as well. Personal and business loans are both installment loans that come with monthly payments. Depending on your needs, there are online lenders that offer varying term lengths for both options. 

The main differences between a business loan vs. personal loan are how a borrower qualifies for one and what you can use the funds for. While you can find a wide range of options for business loans, there tends to be more variety in approval requirements amongst personal loan lenders, which can make personal loans easier to qualify for. The ease makes these options a popular choice for business owners, especially for new companies. A study in the Journal of Corporate Finance found that 55% of companies reviewed relied on their personal credit to finance their start-up.1

Here is an overview of some of the key differences, so you can get a quick look:

AspectBusiness LoansPersonal Loans
Credit HistoryTypically require an established credit history for the business. If not, a strong personal credit history may be necessary.More options for borrowers with subprime credit scores.
Application ProcessRequires extensive documentation to demonstrate profitability and cash flow. You must specify the loan’s purpose and how it will generate revenue for repayment. Some lenders may request a business plan.Typically involves a simpler application process with less documentation and specificity about loan usage.
Business Plan RequirementOften required, especially for new businesses. Detailed business plans may be necessary for startups.Generally not required, and personal financial information is the primary consideration.
CollateralBusiness loans may require collateral such as business assets or real estate to secure the loan.Personal loans are often unsecured, meaning they don’t require collateral.
Repayment TermsBusiness loans usually have longer repayment terms, often several years, to accommodate the financial cycles of businesses.Personal loans tend to have shorter repayment terms, often ranging from a few months to a few years.
Legal StructureBusiness loans are typically provided to legally registered businesses (e.g., LLC, corporation, sole proprietorship).Personal loans are granted to individuals, irrespective of business ownership.
Use of FundsBusiness loans are intended for business-related expenses such as expansion, inventory, equipment, and operational costs.Personal loans can be used for various personal expenses, like debt consolidation, home improvements, education, or emergencies.

How Personal Loans Work

Personal loans are one of the most versatile lending options available, as they can typically be used for almost any purpose. Lenders might inquire as to what you plan to use the loan for, but you are not under an agreement to use the money for any specific purpose.

One of these loans can be used for business expenses and personal expenses alike without restriction. The versatility of personal loans doesn’t stop at their use, as you can find online lenders who offer personal loans with shorter and longer terms, for good and bad credit, and from small loan amounts to more significant loan amounts. 

Even though there is a lot of variety, personal loans tend to be smaller than business loans. The loan amount can range anywhere from $500 to $50,000. Terms on a personal loan can be as short as less than a year up to seven years.

Getting Approved For Personal Loan Funds

Personal loans are typically unsecured, which means they require a higher level of risk for the lender. Since there is no collateral to borrow against, qualifying for a personal loan comes down to your personal credit history. If you have a good credit score and adequate monthly income, you will easily be approved for a personal loan with a competitive interest rate. 

Even though a high personal credit score will help you access better interest rates, there are plenty of online lenders that offer personal loans for bad credit—commonly referred to as bad credit loans—as well. 

These lenders may be flexible with eligibility when compared to credit unions or banks. For example, some credit unions, banks, and similar financial institutions may have minimum credit score requirements. If your personal credit history isn’t good, you may still be able to get approved for a personal loan, but you are unlikely to access very affordable interest rates. As bad credit personal loans tend to have higher interest rates. 

How Small Business Loans Work

Business loans typically come with more restrictions as they are intended to be used for business expenses solely. Generally speaking, a business loan is meant to be used towards expenses that will generate revenue. Ideally, the business loan will generate enough profit in the borrower’s business finances to offset the cost of interest. 

Some business purposes a small business loan might be used for include renting a new commercial space, buying new inventory, hiring new employees, updating your technology, and marketing your business. You might even use a business loan for ordinary everyday business expenses. 

Business loans offer a higher range in loan amount than personal loans, some business loan amounts ranging as high as $500,000. Depending on the size and type of business loan, financing terms can last between six months up to 25 years. A secured business loan utilizes collateral to get a higher loan amount, lower interest rates, or a way for small business owners to be approved despite poor credit. 

Getting Approved For a Small Business Loan

It can be challenging to be approved for business loans unless you already have an established business credit history. If the business loan you are applying for does not require a business credit score, the lender will likely need you to have a strong personal credit history. Personal loans have far more options when it comes to borrowers with a subprime credit score. 

The application process for a small business loan requires more documentation to prove your profitability and cash flow. Unlike personal loans, you will need to specify exactly what the loan will be used for and how it will increase revenue to pay back the balance. Some lenders will ask you to submit a business plan in addition to the other paperwork. If your small business is just starting out, you will definitely need to provide a business plan that is even more detailed. 

When It Makes Sense To Get a Personal Loan

It might be a good idea to use a personal loan for business when you haven’t entirely built a business credit score yet. Your small business may be new, or you may just be in the beginning stages of building it. In these circumstances, a personal loan may suit your needs better by allowing you to be approved through your personal credit score and personal financial history.

Using a personal loan for business needs might also make sense when you need financing quickly. The application process for business loans can take weeks or even months, while many lenders can fund a personal loan as quickly as one business day. 

When It Makes Sense To Get a Business Loan

A circumstance in which it might make more sense for you to apply for a small business loan is when you need a significant amount of financing for your existing business. If your business is growing rapidly, you might need a far more considerable loan amount than a personal loan can offer. The lending limits are much higher on business loans, plus you can access significantly lengthier terms. 

Getting a small business loan can give you an opportunity to build business credit so that your business has further financial opportunities in the future. Additionally, many experts recommend keeping personal finances separate from business to protect your personal liability. Mixing business and personal finances can turn sour quickly if you aren’t careful.

Tips For Paying Off Your Small Business Loan

Simply knowing how to get a business loan isn’t enough when you will eventually need to pay it back. Keeping up with your monthly business loan payments can be intimidating, but if you manage the business finances carefully, then you should be able to remain on track until you’ve paid back the balance in full. 

Here are a few tips for managing your business loan, so you are building business credit:

Create Your Own Repayment Timeline

Design your own detailed repayment plan that sets you up to pay off your loan according to your goals. Make your own timeline so that you can pay off your loan early to save money on charges from high-interest rates. 

Your business loan payment timeline can be unique to the times of the year when you are more and less profitable. During busy seasons, you can make extra payments to put more of a dent in the principal balance. When things are slow, you can account for that by scheduling minimum payments, which you make up for when profits are higher.

If you have multiple business loans or business credit cards, you can factor all of them into your repayment schedule and pay them off more aggressively according to how high their interest rate is. Doing this could save you money and improve your business credit scores.

Cut Down Expenses, Increase Revenue

If you’re struggling to make the payments each month, look closely at your business’ finances to figure out where you might be able to cut costs. Doing whatever you can to cut expenses and increase revenue will make more money available to repay your business loan. You might need to get creative or try new things you haven’t before, but every dime counts.

Consider Refinancing or Consolidation

If your current loan terms aren’t working for you, it might be time to consider refinancing your business loan with loan terms that are more favorable to you. If your business credit has improved since you first took out your business loan, then you might be able to access a better interest rate when applying for a refinance now. 

You also have the option of consolidating multiple loans into one. Getting a consolidation loan to compress a couple of business loans into one could simplify your monthly payments, lengthen your loan terms, and even get you a lower interest rate. 

FAQS: Business Loan vs Personal Loan 

Are there specific industries or sectors where personal loans are more commonly used for business purposes?

While personal loan options can be used across various industries, they are often favored by freelancers, sole proprietors, and startups in sectors where initial capital requirements are relatively low, such as digital marketing, consulting, and online retail.

How do interest rates typically compare between personal and business loans?

Interest rates can vary based on various factors, including creditworthiness and the lender’s policies. Generally, business loans might offer lower interest rates compared to personal loans, especially for well-established businesses with a good credit history. However, personal loans might have competitive rates, especially for individuals with excellent personal credit.

Is it possible to switch from a personal loan to a business loan once the business is more established?

Directly switching from one loan to another isn’t common. However, once a business is established and has a good credit history, the owner can apply for a business lending option and use those funds to pay off the personal loan, effectively transitioning the debt.

Do lenders offer any special incentives or benefits for using a personal loan for business purposes?

Lenders typically don’t differentiate the purpose of a personal loan, whether it’s for personal or business use. However, some online lenders or fintech platforms might offer incentives or promotional rates for entrepreneurs or startups.

How do late payments impact business vs. personal credit scores?

Late payments on personal loans will impact an individual’s personal credit score, while late payments on business loans will affect the business’s credit score. However, for sole proprietors or if a personal guarantee was made on a business loan, there might be credit implications for both personal and business credit.

Are there any tax implications when using a personal loan for business expenses?

When a personal loan is used for business purposes, the interest on the loan may be deductible as a business expense. However, it’s essential to keep clear records and consult with a tax professional to ensure compliance with tax regulations.

Can I have simultaneous active personal and business loans from the same lender?

Yes, it’s possible to have both personal and business loans from the same lender, provided you meet the lender’s qualification criteria for each loan type. However, the approval for one doesn’t guarantee approval for the other, as they are evaluated based on different criteria.

CreditNinja’s Thoughts on a Business Loan vs. Personal Loan 

Both small business loans and personal loans have their differences and similarities, and what the right choice is for you will depend on your needs. Whether you decide to look into personal loans for business purposes or outright small business loans, once you do choose and take out a loan, 

CreditNinja wants to emphasize that it is vital you make your monthly payments on time. That way, you can keep your business and personal credit score in good shape. This will allow you to access future financial opportunities that present themselves to you.

References:

  1. Debt Financing, Survival, and Growth of Start-Up Firms | SSRN
  2. Business Loan vs. Personal Loan: Which Is Better for Your Small Business? | Lending Tree
  3. Small Business Loan vs. Personal Loan: Which Is Right for Me? | Motley Fool 

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