It’s hard to cover operating costs and grow your business if you’re short on funds. In fact, lack of financing is the number one reason why startups fail, according to a 2022 Skynova survey. If you’ve been struggling to obtain business financing, you may be considering a personal loan.
While it’s possible to use a personal loan to fund a business, it’s often more costly than business loans — and there are some important risks to consider. Here’s what you need to know, along with a few situations when funding your business with a personal loan might make sense.
Business loan vs. personal loan
Let’s take a closer look at how business loans and personal loans are different:
Business loans
Small business loans come in all shapes and sizes. That includes term loans, invoice financing, equipment financing and more. Loans that are backed by the Small Business Administration (SBA) typically offer competitive interest rates, large loan amounts and generous repayment terms. Business loans are also available through financial institutions and peer-to-peer lending platforms.
Business loans often require applicants to complete a lot of paperwork and to share financial statements and projections. Your personal credit will likely come into play as well, and some business loans require collateral and a personal guarantee.
Personal loans
A personal loan provides a lump sum of cash that can be used for all kinds of things, including funding a business. You’ll be required to share some basic financial information, such as your credit history and income. These types of loans can unlock quick financing, though loan amounts tend to be lower when compared to business loans.
With a personal loan, you probably won’t have to provide collateral or a personal guarantee, but interest rates can be steep. Personal loans are available through banks, credit unions and online lenders.
Risks of using a personal loan to fund a small business
Interest rates on personal loans are usually higher
Personal loans are usually unsecured. That means they don’t require collateral. Unsecured loans tend to have higher interest rates. With personal loans, rates can vary widely from lender to lender — but they can be as high as 36%. It’s an important detail because a higher rate can significantly increase your total borrowing costs. Having a strong credit score can help you qualify for a personal loan with a lower rate. One other word about interest: unlike business loan interest, personal loan interest is not tax-deductible.
Loan amounts are typically smaller
Business loan amounts range widely, but some can provide up to $5 million in funding. Personal loans tend to offer less. Most range anywhere from $1,000 to $50,000, though some are as high as $100,000. Depending on your business and cash flow, a personal loan could provide all the funding you need. But businesses that need more capital might need to explore other options as well.
Repayment terms tend to be shorter
Business loans are known for their longer repayment terms. They can range anywhere from a few weeks to 25 years. A longer loan term translates to smaller monthly payments. However, one drawback is that the borrower will pay more interest over the life of the loan.
Personal loan repayment terms typically last 12 to 60 months. Depending on your loan amount, that could work out to a large monthly payment. No matter what kind of business funding you choose, you’ll want to be sure that your budget can easily absorb the debt.
Personal loans don’t build business credit
Business loans can help build your business credit history and credit score. That can set the stage for financing opportunities later on, like trade credit with vendors or higher loan amounts down the line. Personal loans don’t offer this perk. Repaying a personal loan can improve your personal credit, but it won’t do anything to boost your business credit.
When it might make sense to fund your business with a personal loan
1. Your business is a startup
To qualify for a business loan, you’ll likely need established business credit and to be operating for at least six months. Most lenders will also request a cash flow history, along with accounts receivable and payable reports. These requirements can create real hurdles for new businesses. A personal loan can be a viable alternative for startups and young companies.
2. You don’t want to use collateral
Business loans generally require some form of collateral. That includes SBA loans that are greater than $25,000. According to the SCORE Association, collateral might be:
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Equipment
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Invoices
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Real estate
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Business and personal assets
Personal loans usually don’t require collateral. That can be good news for business owners who don’t have collateral to secure a loan — or those who simply don’t want to use collateral.
3. You need fast funding
From start to finish, you can expect to wait at least a few weeks to receive funds from a business loan — sometimes longer. For example, the SBA may take 90 days to process your application before making a decision. Some personal loans can provide funding within 24 hours. That can be a game changer for businesses that are up against a financial emergency.
A personal loan can be a solid funding option for some small businesses, but it isn’t without risk. Be sure to do your homework to determine if it’s the right option for you.