Should You Take Out a Personal Loan for Your Small Business?

Finding the right financial backing for a business can be tricky. While it is a relatively straightforward process if you have a history of business success, for first-time entrepreneurs it can quickly become a Catch-22 situation. Without a history of profitable business management, it can be difficult to prove you can manage business finances successfully. One option that many entrepreneurs take advantage of is choosing a personal loan over the choice of applying to a bank or commercial loan.

Using a personal loan as the foundation of your business capital is usually far easier than justifying and obtaining a business loan. Before you commit to this option, it’s valuable to check whether or not this is the most viable solution for you. There are pros and cons to this approach, and being aware of them will make your decision much quicker to reach.

For business owners that wish to meet with non-bank lenders to discuss their needs, regional lenders such as Buffalo Business Loans in Western New York may be a good option.

How does a personal loan for business work?

While there are a number of financial solutions available for those that need to find the required business capital, they have varying degrees of complexity. Modern solutions like crowdfunding are perfectly viable, but they also carry specific risks. Personal loans also carry risk, but they can be much faster to obtain, which is why their use for business financing is so common.

Why is it a useful option?

A personal loan means just that. You are free to spend your loan in the way that you choose, and if that means using those funds for your business, then it’s your decision. A business loan lender will want to see a strong business plan and be assured that you have the skills, experience, and knowledge to drive your business toward success. Personal lenders, on the other hand, will simply need to know that you are going to be able to meet your repayment obligations. Your ability to obtain a personal loan will be dependant on your credit score. If you have a bad credit history and low credit score, then you may struggle to find a personal loan provider who is willing to take a risk on you.

Personal loans for business – what do you need?

While the most significant single factor for a personal loan application is going to be your credit score, you will also need to provide proof of your viability. While you will not need to give any information about your business, you will need to show consistent bank statements, your W-2 or relevant pay stubs, your most recent tax returns, as well as the usual proofs of identity.

“It’s easy to get a loan unless you need it.” Norman Ralph Augustine, U.S. aerospace businessman

 

Is a personal loan for business the right choice for you?

When you’re looking for funds to launch a business, it is always worth checking whether you are eligible for a business loan. You’re far more likely to get low interest rates business loans if your credit score is above 580, so always check before you commit to any loan decisions. However, you should also consider:

  • Your business history: If this is your first business, you may not be eligible for a business loan. In those cases, a personal loan is a useful alternative. As opposed to those hoping to obtain industrial equipment financing or other forms of business loan, you will not have to provide a business plan when applying for a personal loan.
  • The amount required: If you only need a small amount of financial help for your business, then a personal loan is often advantageous. Banks especially are wary of loaning small amounts in the form of a business loan. They can be applied for, but they usually come with high business rates. Personal loans for smaller amounts will result in more manageable interest rates and repayment plans.
  • Lack of collateral: A bank will often deny a business loan if you have a lack of collateral. Of course, alternative lenders like SBA loans are less likely to reject you due to a lack of collateral. One of the reasons why personal loans are so popular for first-time entrepreneurs is that they will usually require no guarantee. It can change if you are hoping to borrow more substantial amounts, but for smaller personal loans, having money in the bank is rarely a prerequisite.
  • Additional pros of a personal loan for business:
    • It is easier to qualify for a personal loan
    • Funds are processed quickly
“Every time the U.S. government makes a low-cost loan to someone, it’s investing in them.” – Elizabeth Warren, United States Senator

 

Cons of a personal loan for business

While there are clearly some advantageous benefits of getting a personal loan rather than a business loan, there are some potential drawbacks too.

  • Credit score risk: If your business fails and you are unable to make your loan repayments, your credit score will be damaged. The lower your credit score, the harder it is to apply for future lines of credit. However, even if your business performs well and you keep up to date on payments, there are still risks. Taking out any form of loan can raise your debt-to-income ratio, and that can make it more difficult in the future to get a mortgage, a bank loan, or even a credit card.
  • Lending limits: Personal loans have lower maximum limits on the total amount that you can borrow. It is difficult to find a lender that will approve a personal loan for anything over $100,000. Compare that to the SBA limit of $5.5million! If you require extensive funds to either launch or grow your business, then a personal loan might not be the best option. An SBA (the US Small Business Administration 504 Loan) has been specifically designed to provide financing for business use and is highly recommended for small businesses.
  • Interest rates: Most personal loan providers advertise their low-interest rates. However, those low rates are commonly reserved for those applicants with excellent credit scores and/or high incomes. If your credit score is low, then you can get hit with some very high interest rates. These could be as high as 35%, and that could eventually amount to double what you borrowed in the first place.

To Conclude

It is difficult to get business funding, especially in the current economic climate. You should always weigh up the pros and cons of each funding option that is available to you. The majority of personal loans from banks, financial institutions, and credit unions have a repayment timeline of two to five years. It could be all the time you need to build your business into a profitable concern.