The Merchant’s Guide to Personal Loans for Business
The fact that startups have a difficult time getting financing is commonly known. Lenders (understandably) don’t want to risk giving money to startups. New businesses don’t possess the history or the revenue required to convince a lender that they’ll get their money back. And while there are other financing options available for startups, they’re often undesirable; you might have to partially give up control of your company, or go through the awkward and potentially bridge-burning experience of asking your family and friends for financing.
If you’re in possession of a young business in need of financing, here’s an option you might not have considered: you can get a personal loan to use for business purposes. Because personal loans rely on your creditworthiness, and not that of your fledgling business, they’re easier for some merchants to attain.
A personal loan is just the type of financing some businesses need to get off the ground. Is your business one of them? Here’s everything you need to know to determine if a personal loan is the right type of financing for your business.
Personal Loans vs. Business Loans
Here are the main differences between personal and business loans:
The biggest difference is how the lenders analyze the risk of lending money to you. If you’re going for a business loan, the lender will primarily look at how well your business is doing. They’ll look take a look at characteristics like revenue, net income, debt-to-asset ratio, business credit, and collateral.
On the other hand, assessing the risk of a personal loan entirely depends on—who would have thought?—your personal characteristics. They’ll care about things like your personal credit score and credit history, source of income, debt-to-income ratio, and use of the loan.
A personal lender does need to know that you’re using the loan for a business venture. This is because the use of the loan determines how how risky you are to lend to. Otherwise, a personal lender will not need to know anything about your business.
Whereas you can get a business loan of up to $1M and beyond (so long as your business is profitable enough), personal lenders aren’t going to offer you significant amounts of money. Expect a maximum borrowing amount of $35K, though you can find lenders that cap it at $50K or higher.
Another commonly known fact: business loans are hard to get without collateral. This isn’t exactly true anymore; marketplace lenders generally go for a combination of a personal guarantee and a UCC-1 blanket lien. This combination, while easier to qualify for, is unfortunately quite nasty in the event that a business owner becomes unable to pay off their loan.
Some lenders claim their loans are “unsecured.” Sadly, even if they technically are, you’re probably not off the hook if you default or your business goes under.
It’s common practice, however, for personal lenders to offer unsecured loans. That means the loan is given to you solely on the strength of your creditworthiness. In other words, it isn’t secured by any collateral. The lender still has the ability to claim legal recourse, but they cannot go after any of your assets.
Unsecured personal loans will have higher interest rates and fees because they carry more risk. For this reason, it’s necessary for somebody who is considering a personal loan for business to either have very good personal credit, or something to offer as collateral.
When Should I Use a Personal Loan for Business?
First of all, if you are interested in getting a personal loan, you’ll need very good personal credit, and a good debt-to-income ratio. If you’ve got a credit score above 640 and a debt-to-income ratio above 50% (43% would be better), you’re in the running to get an unsecured loan. Remember: the better your creditworthiness, the better your rates are going to be. A score of 640 is usually the absolute minimum, so while you might be able to get a loan, don’t expect fantastic rates. If you have something you’re willing to offer as collateral, you’ll be able to get better rates, and your credit score doesn’t have to be quite a good.
If you meet those qualifications, you have a good chance of getting a personal loan. But when should you choose this option over a business loan? Glad you asked.
You should get a personal loan when you have a young (or non-existent) business and when you’ll get more agreeable rates.
If you’re still in the process of getting your business off the ground, a personal loan might be your only option. If youre business isn’t quite in operation yet, business loans are rarely an option.
On the other hand, if your business has been in operation and making money for more than three months, you probably have financing options in the form of short term financing. There are a few reasons you might want to go with a short term lender. A good lender will report to the business credit agencies, for example.
However, the expensive capital and restricting repayment schedules make these loans ill-suited for many businesses that are just starting out. Personal loans tend to be easier to handle because they carry significantly lower monthly payments, and repayment is spread out over a longer amount of time. Unless your business is extremely profitable right off, a personal loan for business is probably a better option.
Eligible for both? Get some quotes and make some comparisons! Lenders should provide quotes free of charge (with no damage to your credit score) so you have some hard numbers to work with.
Marketplace lenders are making it easier for businesses at all stages of life to get financing. Unfortunately, startups will likely always have a difficult time. Good thing we have personal loans! If you’re confident in your business venture and meet personal loan qualifications, using this type of financing for your business is totally acceptable.
A final warning before you go down the personal-loan-for-business path: it’s okay to mix personal and business financials in the beginning, but at some point you’re going to want to separate the two. Even though it’s technically a personal loan, I’d advise those that are able to set up a separate bank account for your business and exclusively use your loan money for business purposes.
Remember that personal loans don’t have to be term loans. Occasionally need a small amount of money to cover unexpected expenses or temporarily make ends meet? Consider getting a personal line of credit.
Don’t want to go through the process of getting a bank loan? Plenty of P2P lenders are significantly faster and offer loans that can be used for business purposes. Some of our favorites are Prosper, Lending Club, and Upstart. As always, don’t forget to make some comparisons!