When you need funding for your business, applying for a business loan may be a helpful next step. But, in some cases, getting a personal loan for business funding may be better.
Personal loans offer young or new businesses an option to get funding without a business financial history. On the other hand, small business loans have many options, such as payroll loans or loans with longer repayment periods.
When it comes to loans for small businesses, both business and personal loans for business have pros and cons. The best option for you depends on your business and financial needs. Here’s what you need to know about the differences between business and personal loans.
How does a business loan work?
Business loans are created to meet the needs of businesses. Traditional lenders, like banks and credit unions, online lenders and other financial companies offer business loans.
When you apply for a business loan, the lender will want to know about your business and its financial history. Most traditional lenders also require at least two years in business, but online or alternative lenders may require a shorter time in business. Lenders will also want to verify your information by reviewing key business documents. The required documents may vary by lender but typically include the following:
- A business license and registration
- Business credit score
- Business plan
- Bank statements
- Current accounts receivable
After applying, you will find out how much loan you qualify for and what interest rate the lender can offer. In some cases, you can go through a preapproval or prequalification process that gives you an idea of the interest rate and loan amount before applying.
Once your loan is approved, you’ll get the funds based on the loan type and the lender’s funding timeline.
Eligibility criteria for business loans
While each lender has its own criteria for eligibility, typically lenders review a business or personal credit score. They will also review the amount of time in business, with some lenders requiring at least two years, while other lenders may approve newly established businesses. Business revenue is another important criteria, with lenders reviewing monthly and annual revenue.
Loan terms and repayment for business loans
Generally, business loans offer longer repayment terms compared to personal loans, with some lenders offering anywhere from two to seven years or longer. Eligible SBA loans may offer up to 25 years for repayment.
Several factors determine how much you’ll pay for the business loan, including the interest rates, length of repayment and loan amount. Business loans often have lower interest rates compared to personal loans, plus larger borrowing amounts.
Types of small business loans
There are several types of business loans, all with different purposes and funding uses, such as business equipment, business operations or commercial real estate.
Here are the main types of business loans:
| Loan type | Amount | Purpose |
|---|---|---|
| Commercial real estate loan | Up to $5 million | Funds can finance the purchase or leasing of a commercial property used for business purposes. |
| Equipment financing | Varies by equipment type | Use for any equipment you need to run your business, from coffee machines to bulldozers. |
| Invoice factoring | 70 to 90% of the outstanding invoice amount | Sell your outstanding invoices to a factoring company to help with cash flow. |
| Invoice financing | Around 85% of the outstanding invoice amount | Similar to invoice factoring, invoice financing uses your unpaid invoice amounts as collateral on a cash advance of those amounts. |
| Business line of credit | $1,000 to $500,000+ | Like a credit card, a line of credit gives you a credit limit to spend and repay as much as you would like within a specified period. |
| Merchant cash advance | $2,500 to $400,000+ | Online lenders typically offer a merchant cash advance based on your credit card sales. |
| Microloan | $50,000 or less | Smaller loans designed for new small businesses to help them get started. |
| SBA loan | $500 to $5 million (varies by loan type) | Loans backed by the U.S. Small Business Administration. There are several SBA loan types available, and uses for loan funds vary by each loan type. |
| Term loan | $1,000 to $1.4 million+ | The most versatile loan option, term loans can be used for various business needs. They can be secured or unsecured and are offered by traditional and alternative lenders. |
Pros and cons of business loans
Pros
- Variety of loan types are available
- Higher loan amounts depending on loan type
- Keeps business and personal finances separate
- Helps build your business credit
- Potentially longer repayment periods
How does a personal loan for business work?
Business loans have strict requirements, so it may be easier to qualify for a personal loan in some cases. Typical requirements include a personal credit score of at least 580, verification of your income and proof of identity, but they can vary from lender to lender. If you can’t qualify for a personal loan, you could consider getting a co-signer who agrees to take responsibility for the loan if you cannot repay it.
Applications for personal loans tend to be fairly short, with more lenient requirements compared to the documents and information needed for a business loan. That said, checking the fine print and speaking with your lender to ensure you can use the loan for business is always a good idea, as some personal loans may have usage restrictions.
If approved, you’ll receive the funds — often within a few days — and can use them for your business needs.
Eligibility criteria for personal loans
Personal loan lenders will typically require a review of a personal credit score and history. They will also place a major emphasis on your debt-to-income (DTI) ratio. This ratio represents how much debt you currently carry compared to your income.
Loan terms and repayment for personal loans
Like a business loan, the amount you pay for a personal loan depends on the interest rate, borrowing amount and repayment terms. Personal loans tend to have shorter repayment options, with some starting at six months and up to five years or more. Personal loans generally have higher interest rates too.
Types of personal loans
There are several types of personal loans, but unsecured tend to be the most popular. Personal loans may have a fixed or a variable interest rate, often with repayment periods of one to five years. Loan amounts also vary, typically between $500 to $100,000.
Here are some of the common types of personal loans you may be able to use for business:
- Term loans: This is the standard type of loan where you get a lump sum of cash that you must repay over the agreed repayment term.
- Personal line of credit: A personal line of credit is similar to a business line of credit. You get a set credit limit, and you can use up to that amount, pay it back and reuse it as much as you want.
- Buy now, pay later loans: Companies like Klarna, Paypal, Affirm and Afterpay offer buy now, pay later plans to purchase consumer items without paying the total amount upfront. This could be helpful if you need to purchase equipment, like furniture or office supplies, for your business.
Pros and cons of personal loans for business
Pros
- Often easier to qualify for
- Quick funding
- Not all loans require collateral
Cons
- Lower lending limits
- Personal liability if you cannot repay the loan
- No opportunity to build business credit
Business loan vs. personal loan
No business is the same, so it’s important to consider your specific needs for funding, including how quickly you need the money and the loans you qualify for, to decide which option is best. Here are some reasons why a business or personal loan would make the most sense.
When to use a business loan
- When you want to build your business credit score.
- When your funding needs are high. Business loans typically have much higher lending limits than personal loans.
- When you don’t want to shoulder personal responsibility for the financial needs of a business.
When to use a personal loan for business
- When your personal credit score is higher than your business credit, giving you a better interest rate or terms.
- When your business is new and you don’t yet qualify for a business loan.
- When you want to get the funds quickly and do not want to opt for a fast business loan — personal loans are usually funded faster than business loans.
Impact on personal and business credit
Even when using a personal loan for business, it will impact your personal credit score and not your business credit. If your goal is building up your business credit, then you will need to consider a business loan instead, which is one of the best methods for building business credit.
Personal liability considerations
One more consideration with credit involves liability. When you’re personally responsible for payments, it means you’re responsible for repayment even if the business no longer operates. It will also appear on your personal credit report.
Not only are you personally responsible for personal loan repayment, a business loan may also require it depending on the structure of your business. This means you’re personally responsible for business debts if the business is structured as a sole proprietorship or a general partnership. Having a business set up as a limited liability company, or LLC, or a corporation can limit personal liability.
Alternatives to business and personal loans
If you’re unsure whether you’d like to take on a new loan for your business, there are alternative lending options. Here are a few ideas:
- Crowdfunding: Many businesses get their start or fund a new venture through crowdfunding. Crowdfunding platforms allow individuals to invest in businesses and products. Investors could receive equity or a reward in return, or the investment could be donation based.
- Bad credit loans: Bad credit loans often have higher fees and interest rates than traditional loans but are an option if you don’t qualify for other types due to poor credit.
- Grants: Look to local small business associations, community organizations or the federal government to find grants for starting a business. Grant money doesn’t need to be repaid, making it a great option for funding.
- Business credit cards: Getting a business credit card can be a helpful way to cover business expenses and build your business credit. You can also take advantage of card perks like interest-free periods and sign-on bonuses. Additionally, interest is only charged when you carry a monthly balance.
The bottom line
Finding the right option for funding your business needs can be tricky. Business loans provide opportunities to build business credit, often with higher lending limits than personal loans. But, using a personal loan for business can bring fast funding and flexibility in getting the money you need. Consider the pros and cons of each option to pick the best loan type for your business and financial needs.
Frequently asked questions
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No, a business loan is different from a personal loan. Business loans are granted to a business, while personal loans are lent to individuals. Business loans typically have higher lending limits and may require collateral, with approval depending on business financials and information. On the other hand, personal loans have more flexibility in how funds can be spent, have shorter repayment periods and use personal information for approval.
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It depends. Sometimes, lenders run a business owner’s personal credit for a business loan. Lenders differ in how they assess business qualifications for a loan. While comparing lenders, be sure to find out what their qualifications and requirements are.
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Sometimes, the personal loan history of a business owner may affect eligibility for a business loan. Lenders may look at personal loans and credit history to determine financial responsibility.
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