Business loans and personal loans are different types of credit, but they can be used for some of the same purposes.
The basic difference is obvious. Personal loans are for personal use, and business loans are for business use. But is there any overlap? If you’re just starting a business, do you apply for a business loan or a personal loan?
Let’s take a closer look.
What is a Business Loan?
A business loan is a business-specific loan. To apply for a business loan, your business must be formally organized as a sole proprietorship, partnership, Limited Liability Company (LLC), or corporation. You will need all of the permits and documents that a business needs to operate.
Different lenders have different criteria for business loan approval. Most will look at the following factors.
- Business and personal credit scores. Business credit is an important part of business approval. If your business is relatively new, or if it’s a sole proprietorship or partnership, expect a personal credit check as well.
- The age of your business. A business with an established operating history has a better chance of loan approval.
- Your revenues. Many business lenders won’t lend to a business with revenues below a minimum level, which may vary with different lenders.
- Your industry. Some lenders may not lend to businesses in specific industries.
- Your business plan. Expect to submit a detailed business plan and an explanation of how you intend to use the loan proceeds.
Business loans may be secured or unsecured. A secured loan will have a lower interest rate and easier approval, but if your business can’t pay, it will lose the collateral securing the loan.
What is a Personal Loan?
Personal loans are made to individuals. They are usually not tied to a specific purpose, and people use them for many different types of expenses.
Personal loans are installment loans: you’ll borrow a fixed amount and pay it back in equal monthly installments over a fixed loan term. Most personal loans are unsecured, but some lenders do offer secured personal loans.
Personal loans are offered by banks, credit unions, and online lenders. Loan limits usually range up to $50,000 or even $100,000 for qualified borrowers, and terms usually range from three to five years.
Differences Between a Business Loan vs. a Personal Loan
There are important differences between business loans and personal loans.
- Collateral. Both personal and business loans may be unsecured, but business loans are more likely to be secured, while personal loans are more likely to be unsecured.
- Term. Business loans may have extended repayment periods, often up to ten years or more. Personal loans must be paid off more quickly.
- Amount. At least for qualified businesses, business loans are available in much larger amounts than personal loans, often in the millions of dollars.
- Tax Deduction. Interest paid on business loans can be tax deductible under local laws (check with a tax professional). Personal loan interest is not tax deductible.
- Interest Rates. Personal loan rates are generally higher than those for business loans. Business loans have a more rigorous approval process and usually offer less risk to the lender than personal loans.
Those features make a business loan look like a better way to fund a business. There’s a reason for that: it’s what business loans are designed to do. There are still pros and cons to both loan types.
Can I Use a Personal Loan for a Business?
Some lenders will permit you to use a personal loan for business purposes.
However, when you apply to a personal lender, remember that you will need information about how you plan to spend the cash. Your business purpose must meet their lending criteria to qualify.
A personal loan lender will base your creditworthiness on your personal finances, including your credit score and debt-to-income ratio, not the state of your business.
⚠️ Even if you take out a personal loan for business purposes, you are liable for payment, not the business.
Pros & Cons of Business Loan vs. Personal Loan
Take a look at the advantages and downsides of using a business loan vs. personal loan to finance a business.
Pros & Cons of Business Loans
Business loans are usually a better choice for a business, but not always.
- Larger loan amounts. Most business lenders have higher maximum loan limits than personal loan lenders.
- No personal liability. The debt is the responsibility of the business, not the individual.
- Tax-deductible interest. You may be able to deduct interest payments on your business (not personal) tax filing.
- Limited availability. New businesses may be unable to get business loans.
- Debt can be a problem. Businesses with existing loans or other debt may not be approved.
- Strict requirements. You must provide detailed documentation of your revenues, costs, and business plan.
- Longer approval times. The more detailed application requirements for business loans mean that the time required for review and approval is longer.
Pros & Cons of Using a Personal Loan for Business
Personal loans can be an option to finance a business, but there may be better options. Look at the pros and cons.
- Quick Application. A personal loan application can often be approved in minutes, and the funds can be released within a day.
- Less Paperwork. Personal loans typically require a minimum amount of documentation. You are not required to provide your company’s balance sheet/business plan.
- Personal Loans Are Usually Unsecured. You won’t risk assets belonging to you or the business.
- A Personal Loan May Provide Startup Money. Most small business lenders do not advance money to startups. A personal loan might be a good option if you are in that category.
- Personal Loans Do Not Establish Your Business Credit. They only have an impact on your individual credit rating. This will make it difficult for your business to establish its credit history.
- You are Personally Liable. You are personally responsible for everything that happens in connection with the loan collection and everything that follows, not the business.
- Personal Loans are Related to Personal Income. The amount you can borrow will be limited by your personal income.
If you need an investment beyond what your income warrants, a personal loan will not help you.
- Blending Personal and Business Expenses. Using a personal loan for a business can complicate your accounting and taxes.
- Higher Rates. Personal loans typically have higher interest rates than business loans.
How to Choose
The choice between a business loan and a personal loan will be largely based on the circumstances of your business.
When a Business Loan is Best
- Your business is well established. A solid operating history will improve your chances of being approved for a business loan.
- Your business needs a large amount of money. In that case, a business loan will probably be a better option.
- You’re trying to establish business credit. A personal loan won’t help you build business credit.
- You don’t want your personal assets to be at risk. You will not be personally liable for a business loan.
💡 Tip: If you get turned down for a business loan, consider it a reality check on the viability of your business. Ask for the criteria the lender used, and address the issues.
When a Personal Loan for Business Can Make Sense
- You need cash quickly. Some personal loan lenders may offer funding within one day. You may have to wait for some business loans.
- Your business is new. If your business is new or hasn’t yet built a solid credit history, you may have a better chance of being approved for a personal loan.
- You don’t have collateral or don’t want to use collateral. Most personal loans are unsecured.
- You need a relatively small amount. If you don’t need a large loan, the convenience of a personal loan is appealing.
Alternative Ways To Get Funding For a Business
Business loans are not the only way to get funding for a business. Here are some other options.
Small business loans from NBFCs, MFIs:
- Self-Financing your Startup. Using your own money offers the greatest flexibility if you can afford it.
- Microloans. Non-profit groups offer very small loans to people starting small businesses. These may be focused on specific groups, like minorities, women, or veterans.
- Crowdfunding. If you have an appealing product and story or a wide circle of friends, crowdfunding may raise the capital you need.
- Getting an Angel Investor. If your business has strong growth potential, it may attract investors. Seek legal advice before signing anything!
- Peer-to-Peer Lending. Some peer-to-peer lending platforms offer business lending.
- Government Lending Programs. Aside from SBA loans, many state and local governments support startup businesses. Look into what’s available in your area!
Financing a new business isn’t easy, but it doesn’t have to be impossible. Be creative, look for all possible financing options – there may be more than you think – and don’t give up!