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Starting a small business is not an easy task. It takes a lot of time, patience, planning and often a lot more money than you might expect. Fortunately, there are financing options that prospective small business owners can turn to. Two of the most common are small business loans and personal loans. And while they may seem really similar and practically interchangeable, there are actually some very important reasons why you might want to choose one over the other.
Select spoke with a financial expert Ashley Rousseau in analysis when it may (and may not) be beneficial to take out a personal loan to start your own small business.
What is a personal loan?
ONE A personal loan is a line of credit commonly used for large purchases. As the name implies, it is a personal loan personal, which means it can be used to cover the cost of anything that is important to your personal circumstances. This can be house renovation, wedding, funeral expenses, relocation expenses, emergency expenses and more.
There is not really a strict rule about what the loan should be used for (although, you usually need to explain your plan for using the money when applying for the loan). You can even use it to pay off many credit card debts – this way, you can effectively “consolidate” your credit card debt into a personal loan that you will repay.
Personal loans usually have a much lower interest rate compared to credit cards. For reference, the current APR average for a two-year personal loan is 9.58% while the average APR for a credit card is 16.30%, according to Federal Reserve.
For the most part, the interest rate you will be charged will depend on your credit score. And while different lenders have different minimum credit score requirements for approval, the higher your credit score, the more likely you are to have a lower interest rate and more favorable loan repayment terms.
Another important distinction is that personal loans usually have a fixed repayment period. This can range from a few months to a few years. And depending on the lender, you may be charged a commission if you repay the loan earlier, before the end of the repayment period. Some lenders will also charge a home fee, but if you want to avoid it, you can only look for loans without one, such as Discover the Personal Loan.
For a better idea of what other personal loans are out there, you may want to browse our list of the best personal loans.
Annual percentage rate (APR)
Purpose of the loan
Debt consolidation, home improvement, marriage or vacation
End of origin
Early repayment penalty
A small business loan is similar to a personal loan, but it is intended to help entrepreneurs obtain financing for a variety of expenses arising from the operation of their business. Some of these loans may be requested through the US Small Business Administration (SBA), however, you can also apply for small business loans through commercial banks, community banks, peer-to-peer lenders such as Financing Cycleand online lenders like Cabbage.
There are also some different types of business loans. A small business credit line provides you with a certain amount of credit from which you can withdraw and receive cash, and you will pay interest on what you borrowed (much like you would with a credit card). And working capital loans are meant to help you cover the day-to-day running costs of your business – such as payroll and rent for your office or workplace. These are just two types of loans that you should consider, but there are other types of business loans that may best suit your needs.
The short answer is yes, a personal loan can also be used to cover the costs associated with starting a small business.
“Once you are approved for a personal loan, you can use it in any way that makes sense,” said Ashley Russo, Financial Planner and Educator. “If you are starting a small business, you can use your personal loan to cover everything from inventory to payroll to rent. But you can consider doing it at the lowest possible cost for you, which means getting a loan. at the lowest possible interest rate. “
When can it make sense to use a personal loan for my small business?
So now you have two really great options for financing your small business. But there are some things to keep in mind when calculating which type of loan is best for you.
Keep in mind that when you are going to apply for a small business loan, some lenders may ask you for some business related documents before you are approved.
“Some banks will require tax returns or scraps for your business or may ask you to provide a business plan,” Russo said. “With personal loans, on the other hand, you do not need to show any business interest to be approved for a loan.”
You can just ask the lender if you can use the personal loan for business purposes. It is best to be aware of your intentions in advance to make sure you are not violating any loan terms. Using a loan for prohibited purposes could result in the lender forcing you to repay the full amount plus interest immediately.
In addition, if you do not have collateral that can be used to secure your business loan, you can choose unsecured personal loan. A secured loan means that if you fail to make payments, the lender may seize an asset (your car, your home or your small business, this could be your stock) that you provided as collateral. Some small business lenders will ask you to secure a loan with an asset, while personal loans are usually unsecured.
Another thing to consider is how much money you plan to borrow. Most SBA loans allows you to borrow up to $ 5 million in business expenses. Most personal loan lenders will approve you for up to $ 100,000.
When can it make sense to apply for a small business loan?
The amount of money you can borrow for each loan is a very important issue. If you think you will need more than $ 100,000 to get started, you may want to consider applying for an SBA loan as they have higher ceilings. Creating a business plan and budget can help you determine what your exact needs may be.
Also, keep in mind that personal loans are linked to your personal credit history. So if you are lagging behind in payments, your personal The credit score may suffer and this may make it difficult for you to get approval for other credit limits, such as a new credit card, car loan or mortgage.
Both personal loans and small business loans are cost effective ways to start your own small business. Your choice may depend on how much money you really need, where you can get the lowest interest rate and whether or not you want to put your personal credit on the line.
If you are applying for a personal loan, be sure to read the terms of the loan in advance to make sure that you can use the loan for business purposes. If it is not clear, you should ask the lender directly. Also, make sure that you spend some time developing a business plan and a budget that can help you clarify your needs.
“It’s hard to know where you’re going if you do not know where you are,” Rousseau said. “When creating your business plan, calculate your revenue expectations and learn how to repay the loan before you even apply.”
Editorial Note: The opinions, analyzes, reviews or recommendations expressed in this article are those of Select publishers only and have not been reviewed, approved or otherwise endorsed by any third party.