Cash News
Starting a small business is expensive, with many new small business owners relying on personal savings or investments from friends and family for initial capital. But what happens when you still need funding to pay for equipment, space, and other expenses to help your business grow and thrive?
Personal loans can help fund your new business or cover your company’s expenses, but a personal loan for business isn’t always the best choice.
Let’s look at how to use a personal loan for business, when it’s a good idea, and the pros and cons of business loans vs. personal loans.
Can you use a personal loan for business?
You can use a personal loan for a variety of reasons, such as home improvement, funding a vacation, or consolidating your debt. Personal loans may also be used for business, helping to provide startup capital, or pay for business expenses — though some banks, financial institutions, and lenders may restrict or even forbid personal loans for business use.
A personal loan is a type of installment loan, which means you repay it over a set period of time — the loan’s term. In general, personal loans are unsecured and don’t require collateral, an asset the lender would repossess if you fail to pay the loan back.
They’re easy to apply for, requiring a credit check to determine if you have:
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A good personal credit score, that is, typically a FICO score between 610 and 640 or higher, though you may also apply with a co-borrower or co-signer or apply for a bad credit personal loan
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Established credit history, with a diverse mix of accounts and a history of on-time monthly payments
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A low debt-to-income ratio (DTI), which compares your total debt to your gross monthly income and lets lenders know if you can afford to take on more debt
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Stable income
Because you don’t need to provide heaps of paperwork when applying for a personal loan, getting approved is quick — which is important when you’re just starting out.
But it also means that you’re personally on the hook for the loan (hence it being a personal loan). If your business fails or you can’t afford to pay back the loan, your personal credit takes a hit — not your business credit. This may make it difficult to qualify for other types of credit, like credit cards, auto loans or even a mortgage. And if you secured the loan with an asset, like your car or home, your lender may take it to help recoup its losses.
How to use a personal loan for business
After shopping around and getting approved for a personal loan, how can you use it for your business? Unless your lender stipulates otherwise (which would be discussed and covered during the loan application process), you can use the lump-sum funds for anything you want, including:
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Equipment and tool purchases
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Inventory costs
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Labor costs and payroll
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Maintenance, repairs, and renovations
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Rent and property
In other words, you’re only limited by the total amount you can borrow. This means you can use the funds from a personal loan to launch your business, pay for space, purchase inventory, hire employees and otherwise grow your business.
Other types of business funding
Private lenders, such as banks, credit unions and online lenders, offer a variety of business financing options for entrepreneurs, including:
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Business loan: An installment loan that pays out a lump-sum payment upon approval
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Business line of credit: A flexible loan that pays out funds as needed, up to a defined limit
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Equipment loan: A loan that helps you pay for equipment purchases over time
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Business mortgage: A loan to buy, renovate, or refinance a business or commercial property
But traditional business loans aren’t easy to qualify for. Many business lenders require you to meet certain requirements to qualify, such as:
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Minimum revenue (for example, $100,000 in annual gross sales)
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Minimum time in business (for example, two years or more)
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Ability to secure the loan with collateral (whether an asset, down payment, or security deposit)
You can also apply for a business loan guaranteed by the U.S. Small Business Administration (SBA). These types of loans are offered by banks and credit unions and backed by the SBA, reducing the lender risk and making it easier for you to get funding with competitive rates and flexible eligibility requirements. SBA-backed loans include:
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7(a) loans: A 7(a) loan is the SBA’s primary business loan. 7(a) loans may be used for working capital, refinancing business debt, buying or improving business property, purchasing supplies and tools and changes of ownership. To qualify for a 7(a) loan, you must be actively operating a for-profit business, be located in the U.S., meet the SBA’s size requirements, not be a type of ineligible business, be creditworthy and able to repay the loan and be unable to get approved for a loan with reasonable terms from other sources. 7(a) loans are limited to a maximum of $5 million (though some 7(a) loan amounts are capped at $500,000).
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504 loans: A 504 loan is a long-term, fixed-rate business loan to purchase or repair real estate, equipment, machinery and other assets. 504 loans are offered through Certified Development Companies (CDCs) and can’t be used for working capital, debt consolidation or refinancing or investments and must be used to purchase equipment or property that promotes business growth and job creation. To be eligible for a 504 loan, your company must be for-profit, have a net worth of less than $15 million and earn an average net income of less than $5 million for the two years before you apply for a loan. 504 loans are limited to a maximum of $5.5 million.
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Microloans: Microloans are small business loans provided by nonprofit community-based SBA intermediaries. These loans can be used for working capital, inventory, supplies, furniture, tools and equipment, but may not be used to pay off debt or buy real estate. Microloans are limited to $50,000, with each intermediary setting its own eligibility requirements. In general, you’ll need to provide some form of collateral and a personal guarantee to repay the loan, which must be repaid within six years.
When it’s a good idea to use a personal loan for business use
Though personal loans are viable alternatives to business loans, they’re not always the best financing option. Still, you may want to consider a personal loan for business use when:
You don’t qualify for business funding or SBA loans
Formal business funding options tend to have steeper requirements and more restrictions than personal loans. If you’re just starting your business, you may not have enough revenue or time in business to be approved. And SBA loans restrict how you can use the money.
If you don’t meet the loan requirements of a business or SBA loan, a personal loan may be easier to qualify for, even if you need to compromise on the amount of money you borrow.
You have good personal credit
When you take out a loan, the interest rate is based on how much you borrow, how long you have to repay it and your creditworthiness. In general, the lower your credit, the higher the loan’s interest rate — and the more difficult it is to qualify for the loan.
The same goes for your business credit. If you have low or insufficient business credit, you may be asked to make a personal guarantee to repay the loan. This means that if your business can’t repay the loan, you would be personally responsible for doing so — which means your personal assets, like your home, may be taken by the bank if your business defaults.
One of the ways to avoid a high interest rate or the necessity for a guarantee is to take out a personal loan. Not only are personal loans easier to qualify for, but lenders only take your personal finances into account when calculating the loan’s interest rate. If you have good or excellent credit — a solid credit history with little to no late payments or defaults and a credit score of around 670 or higher — you may qualify for an unsecured personal loan with favorable or lower interest rates, saving you money and avoiding the need to put up collateral.
You don’t need much capital
Taking out a small business loan can give your business access to millions of dollars. But what if you don’t need that much capital?
Most personal loans are capped at $40,000 to $50,000, though some personal loan lenders will offer loans of up to $100,000. However, most microbusinesses and home-based businesses only need about $2,000 to $5,000 to start, so you may not need a business loan at all — at least right away.
In this case, a small personal loan can serve you well, giving you access to funds with few restrictions.
You know you can repay the loan
When you take out a personal loan, you agree to be held personally responsible for paying it back. This means accepting and understanding that late payments or a loan default will impact your credit and make it difficult to qualify for new loans in the future — even those unrelated to your business such as an auto loan or mortgage.
Even if your business fails, you’re on the hook for repaying any personal loans that are still open.
In other words, taking out a personal loan for your business can be risky — unless you know you can pay it back without relying on business income.
You need flexibility
When you take out a business loan, how you use the funds may be limited by your lender or the SBA. For example, if you only qualify for a microloan from an SBA intermediary, you can’t use those funds to purchase real estate, like a storefront.
On the flip side, the best personal loans often have fewer restrictions than commercial funding options. This means you can use the funds to grow your business how you see fit, whether you need to pay off a business debt, purchase inventory or cover your payroll.
You need funding fast
Getting approved for a business loan may take a while — anywhere from 30 to 90 days for an SBA loan. Applying and qualifying for a personal loan is a straightforward process, requiring only proof of identity (like your driver’s license and Social Security number), proof of address, and proof of income. This means you may get approved and receive funding in as little as one to five days — if not on the same day.
Pros and cons of using a personal loan for business purposes
Using a personal loan for business purposes may make sense for your business, but there are some considerations to keep in mind before you sign on the dotted line. Weigh the following pros and cons of using personal loans for business to decide if it’s right for you and your financial situation and goals.