A Practical Guide to Using a Personal Loan to Start a Business
Starting a new business is always an exciting venture. But it doesn’t come without challenges and stressors – money being a big one.
You need money to start any business. Even if it’s completely online and service-based, there are fees associated with incorporating, building your website, and using tools and systems to run your new operation.
Sometimes, personal loans can be a great source of capital to get your idea off the ground.
What are personal loans for businesses?
A personal loan is a type of loan that allows you to borrow money from a lender under your personal name. You can use them for business purposes as well. They’re unsecured loans, which means you don’t have to put up any collateral or business assets to qualify for the funds.
Instead, it’s a bit riskier on the part of the lender because there are fewer assets to back their investment. Thus, personal loans are based purely on the borrower’s qualifications, and borrowers must pay them back in fixed monthly payments.
A study found that personal loans are the fifth most popular funding type with 11% of merchants applying for them in 2019. Business loans are by the far the most popular, at 53%.
The study also found that business loans have a 67% approval rate. However, personal loans are approved almost as much, 55% of the time, and come with their own sets of pros and cons, which we’ll get into in a bit.
What can small businesses use personal loans for?
Personal loans are more flexible in terms of how you use the money. You can put it all towards a single business initiative, or you can divvy it up among various priorities. Here are some ideas:
- To start a business: Small business owners spend an average of $40,000 in their first year of business alone. That’s a lot of capital to come up with before you’ve even started making sales. A personal loan can help you get off the ground.
- For marketing and advertising: If you need a boost in promoting your business, you could allocate personal loan funds towards marketing and advertising. There are many ways you can go here – from investing in branding to going all-in on a paid advertising campaign for a major promotion.
- To buy equipment for business: You can use a personal loan to invest in equipment for your business if you need it. Remember to account for its depreciation when doing your small business accounting.
- For supplies and inventory: Similar to equipment, you can use capital from your personal loan to invest in more inventory or related supplies for your business.
- For working capital: Working capital measures how many assets you have in comparison to your liabilities. If your liabilities are too high relative to your assets, you can boost assets and working capital through a personal loan.
- For emergency purchases: While it’s a good idea to have an emergency cash reserve, there may be instances when that capital isn’t enough or is inaccessible for some reason. Emergencies happen, and a personal loan can help if needed.
- For expansion: Ready to grow your business? You may need to invest in new technologies or a new storefront, for example. You can use capital from a personal loan to fuel your business growth.
When should you use a personal loan for business financing?
There are some scenarios when it could be more beneficial to take out a personal loan for your business instead of a traditional business loan:
- Your business has no or limited credit/credit history
- You have strong personal credit/credit history
- You don’t own a business yet, so there’s no business entity to borrow
- You’re in a high-risk industry, which makes approvals difficult and APRs high
- You need a lot of money and will supplement other funding sources
Benefits and drawbacks of using a personal loan to start a business
Like most things in business (and life), there are pros and cons when it comes to taking a personal loan for business. We’ve summarized them below:
Benefits of personal loans for business
- Easier approvals than business loans: Small businesses are generally viewed as more precarious and less reliable than individuals (especially those with a good credit history). So, SMB loans typically come with stricter qualifications, terms, and restrictions. While Small Business Administration (SBA) loans can take weeks or even months to get approved, you can expect personal loan approvals a lot more quickly. You don’t even need to provide extensive documentation or business plans.
- No collateral needed: Other sources of capital typically require some sort of collateral to guarantee repayment should you run out of cash to make your repayment installments. This offers more protection to your assets.
- Use the funds how you want: While SMB loans also come with parameters around how you use the capital, personal loans grant more freedom in this area. You can use the money how you see fit – not how the lender thinks it should be used.
- Relief from higher interest rates: If you have a strong personal credit score, personal loans may often come with lower interest rates and more favorable repayment terms.
- No need for a business credit history: Personal loans don’t require a long business credit history or a good business credit score. In fact, they require no business information at all because the lender issues funds to the individual, not the business
Drawbacks of personal loans for business
- Personal risk: Because you’re taking the loan out in your name, your personal assets and credit report are at risk should you run into repayment challenges.
- Limited lending: Business loans often get you access to higher amounts of capital. However, personal loans usually come with smaller loan amounts. While these might be suitable for small startups, if you have an established business with bigger business needs, you might need to look for other options.
- You can’t build a business credit history: Your business may continue to have limited creditworthiness if you take out a personal loan because it doesn’t apply to your business. Instead, your personal credit history is impacted.
- Limited needs: Personal loans are only available as term loans or a line of credit. However, there are a variety of business loans available specifically suited for various business needs like equipment financing or invoice financing.
- Impacts your personal credit: While regular repayments will have a positive impact on your credit, taking out a personal loan for business could put you in a bind if you’re looking to borrow in the near future for another purpose. This includes things like applying for a mortgage to buy a house, a new credit card, or a personal loan for other purposes.
- Mixes business and personal finances: It’s much simpler to keep work and personal finances separate. But when you take out a personal loan, this intermingles the two and makes bookkeeping and accounting a bit more complex.
- No tax write-offs: Personal loan payments don’t qualify as business expenses for tax write-off purposes.
Can you get a personal loan to start a business with bad credit?
While anyone can apply for a personal loan to start a business, the answer is more nuanced than that. The better your personal credit history, the better your chances are at not only getting approved but also getting affordable interest rates and repayment parameters.
How to apply for a personal loan to start a business
To apply for a personal loan to start a business, you’ll first need to choose your lender (we offer three recommendations towards the end of this post).
There are different types of business lenders, including big banks, small regional banks, online lenders, local credit unions, financial institutions, and other alternative lenders. “Institutional” loans are approved most frequently, according to Statista. But personal loans are also available from the same lenders, with their own terms.
Once you have chosen a lender, you’ll need to follow their respective loan application process. While each lender has its own requirements and eligibility criteria, you’ll likely need the following regardless of where you’re seeking financing:
3 best lenders who offer personal loans to start a business
Finding the best lender is really a personal choice and depends on so many individual factors. It’s best to shop around for the best rates and repayment options. You should also look for a lender who offers soft credit checks, transparency, good customer support, and reports payments to credit bureaus. Here are three good lenders to start with:
1. Rocket Loans
- Qualification criteria: To start, you need to live in the US and be at least 18 years old (19 if in Nebraska or Alabama). Rocket Loans isn’t available in all 50 states, though they don’t publish a list of where they are/aren’t available. You also need to have excellent credit to get approved. You’ll need at least a minimum credit score of 640, two years of credit history, and a maximum debt-to-income ratio of 40% or 70% including mortgage.
- Interest rate: APR varies from 5.97%–29.99%. If you chose autopay, you could be eligible for a discounted interest rate. A 1%–6% origination fee is deducted from the loan balance before the lender sends funds.
- Terms: You can borrow $2,000–$45,000 on a three- or five-year repayment plan.
- Pros: Rocket Loans is great for businesses in need of money quickly, offering same-day funding (provided that your information can be verified in time). They also provide a rate discount for borrowers who set up autopay.
- Cons: With only two repayment terms and no option for borrowers to change the payment date, Rocket Loans is quite rigid.
- Qualification criteria: LendingClub also requires US-based applicants who are at least 18 years of age. Residents of Iowa and US territories will have to look elsewhere, though. You need a minimum credit score of 600, at least three years of credit history, and a maximum debt-to-income ratio of 40% for single applicants (35% for joint applicants).
- Interest rate: APR varies from 8.05%–35.89%. There’s also an origination fee of 3%–6%, applied when you receive the funds.
- Terms: You can borrow up to $40,000 on a three- or five-year repayment plan.
- Pros: LendingClub offers joint and co-signed loan options, which can help you get better rates if your personal credit is lacking. Applications and approvals are online, and you can instantly check your rate without impacting your credit score.
- Cons: LendingClub limits borrowers to only two repayment options – somewhat less flexible than a few other loan options. Plus, there are no autopay discounts available.
- Qualification criteria: Applicants must be at least 18 years old and have no bankruptcies within the past year. Requirements also include a minimum credit score of 640, two years of credit history, three open accounts, and a maximum debt-to-income ratio of 50% (excluding mortgage).
- Interest rate: APR varies from 7.95%–35.99%, depending on the borrower’s financial profile. There’s also an origination fee ranging from 2.41%–5.99%.
- Terms: You can borrow anywhere between $2,000 and $40,000 on a three- or five-year repayment term.
- Pros: Like LendingClub, Prosper has a joint loan option. This option is helpful for business owners who wouldn’t qualify for a loan on their own.
- Cons: Prosper only offers two repayment options and no discounts.
Alternate financing options for startups
If a personal loan for your business doesn’t sound like the right fit, there are other financing options available to help you get started. Check out the following, for example:
- Personal finances: If you have enough of a cushion in your personal funds or you’re willing to take the risk, you can fund your business venture yourself. This helps you maintain complete control over the business, though it involves a significant amount of risk.
- Partnership: You don’t have to be a solopreneur to start your own business. Partner up with a fellow business owner so you can combine forces – and funds.
- SBA loans: One of the more common ways to get business funding, you can apply for a small business loan through large and local banks, credit unions, and other financial institutions. Rates and terms vary greatly.
- Merchant cash advance: Merchant cash advances (MCAs) allow you to borrow money in exchange for a portion of your daily credit card receipts, as well as any other fees (typically around 20%). There are more stringent requirements for this form of lending.
- Business credit card: Business credit cards are a great way to have fast access to capital, though they often come with a high APR. Make sure you can pay it back in full before the next billing cycle to avoid exorbitant fees.
- Investors: You can raise capital through investors. This can be a quick way to gain access to capital, though it comes with an added layer of bureaucracy and responsibilities to your investors.
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