Insufficient funding can be a major roadblock to realizing the dream of business ownership, which is why many business owners take on debt to get up and running. A popular option among small business borrowers is to take out a personal business loan. Issued by banks, credit unions and online alternative lenders, personal business loans are unsecured loans that you pay back monthly over a fixed period. However, before you take out a personal loan for your business, make sure you understand the pros and cons of this type of financing, because it's not a good fit for everyone.
"If you have a clear plan in terms of growth and understand the risks involved, it can make sense," Nishank Khanna, chief financial officer of Clarify Capital, told business.com. "That being said, there's a much higher risk with a personal business loan than taking a business loan."
Can you use a personal loan for business?
Yes, you can take out a personal loan to fund your business. Often, small business owners pursue this option if they cannot obtain a small business loan. Small businesses are the heartbeat of the U.S. economy, but the success rate among them is low. According to the Small Business Administration, only half of businesses with employees make it past the five-year mark, and the coronavirus pandemic has only exacerbated that problem.
As a result, lenders have strict requirements when issuing small business loans and go to great lengths to ensure they're protected. With a small business loan, the lender looks at both the company and the small business owner's credit score. Personal loans, by contrast, are often easier to get and have different requirements. They are also an attractive financing option for small business owners because there are typically no restrictions on what the money can be used for. [Need a small business loan? Check out the lenders we recommend for small businesses.]
How do personal loans for business work?
Options abound for small business owners who are looking to take out personal business loans. You can get a personal business loan from a bank, a credit union or an online lender, or even a loan marketplace or crowdfunding website. Many of these lenders have online applications that take only minutes to complete.
Personal business loans typically have fixed interest rates and fixed loan terms averaging 12 to 60 months. The underwriting is less stringent than it is for a small business loan; the lender looks at your credit score, income and debt-to-income ratio. Approval is quick, with some online lenders boasting preapproval times of under two minutes. If you're applying through a bank or traditional lender, expect the process to take longer.
What are the pros and cons of personal business loans?
Before you apply for a personal business loan, consider the pros and cons:
Pros of personal business loans
- They're easier to get. When underwriting personal loans, lenders look at your personal credit score, your income and your debt-to-income ratio. They don't care how your business is doing or what you intend to use the money for. As long as you're creditworthy and your debt-to-income ratio is respectable, you'll be approved. That's not the case with business loans, for which lenders consider the health of the business.
- They don't require collateral. A personal loan is an unsecured loan, which means you don't have to offer collateral. If the debt goes unpaid, there is no hard asset you'll lose as a result. Business loans, by contrast, do require collateral, sometimes multiple times the value of the loan. That precludes many business owners from taking out business loans.
- They can have lower interest rates than business loans. Depending on your personal credit score, a personal loan may be the cheaper option. The terms of a business loan are based on your personal credit score and the financial health of the business. If you've struggled in the past or are just starting out, you'll pay more to borrow. With a personal loan, it's your credit score that matters. If it's high, you'll get a lower interest rate, even if your business hasn't shown a profit.
- Their uses are flexible. For personal business loans, lenders don't care what borrowers do with the money as long as they pay it back. Some lenders have restrictions, but most don't ask where the proceeds will go. That gives you the freedom to use your personal loan any way you see fit.
Cons of personal business loans
- You're mixing business with your personal life. It's a big no-no for business owners to mix business and personal expenses, and that's true of loans as well. By taking out a personal loan to use for your business, you're commingling two aspects of your life. If things go awry in one area, it could affect the other.
- The loan maximums are smaller. Personal business loans tend to range from $1,000 to $50,000, which may be too small for some borrowers' needs. Business loans have much higher limits.
- You need a personal guarantee. Although you don't need collateral with a personal business loan, you do have to personally guarantee it, which puts you and your assets at risk. If you default on the loan, the lender can't come after your business, but it can come after you personally. The lender can take you to court, attempt to seize assets and employ other tactics to collect the debt. Moreover, late and missed payments will appear on your personal credit report, which could lower your credit score.
- You don't build up business credit history. To get a business loan or business credit card, you need to establish a business credit history, but that won't happen with a personal loan, which is tied to you, not your business.
What should I consider when looking for a personal business loan?
Borrowing money isn't free. Lenders are in business to make money, so they charge you interest over the life of the loan. In addition to the interest, they tack on other charges, including application fees, origination fees, prepayment penalties and late fees. Those fees vary and are negotiable, but they also make it hard to comparison-shop for a personal business loan.
That's why you should look at the annual percentage rate of the loan instead of the interest rate: It gives you the total cost of borrowing, including all of the fees, said Josh Jones, chief revenue officer at Kapitus. "The most important thing to understand is the true cost to borrow."
Can you pay it back?
Outside of the cost of the loan, you'll need to determine if you'll have the ability to pay it back; you don't want to saddle a new business with debt you can't repay. If there isn't a clear path to repayment, it's best to consider an alternative.
What is your credit score?
With so many lenders to choose from, shopping for a personal loan can quickly become overwhelming. Who has the time to sift through all the lenders, let alone compare their rates, terms and loan amounts? To narrow your search, know your credit score before you start the process. Lenders set credit score requirements for their loans. Some work only with borrowers who have high credit scores, while others focus on subprime borrowers or those with bad credit. If you know where your credit score falls, you can narrow down the list of lenders, thereby saving you time.
What do I need to apply for a personal loan for business?
The lender may require you to submit some or all of the following documents along with your application:
- Driver's license or official government-issued photo ID
- Bank account number
- W-2
- Tax returns
- Employment verification from your employer