For many companies and individuals, getting a loan can be a viable option to get access to immediate cash for both business and personal needs. However, there is no one-size-fits-all type of loan.
Whether you are a seasoned entrepreneur with a business in a cash crunch, or a new contractor looking for capital to take your business off the ground, you need to consider your financial needs to understand which type of loan is right for you.
Business loans provide capital for growing your company while personal loans can be used for nearly any purpose. How do you differentiate between the two? How would you know which type of loan is right for your current needs?
To help you make this decision, we’ll break down the major differences between business and personal loans, and discuss financing alternatives so you’ll have something to fall back on if loans aren’t right for you.
- Business loans can be useful for funding entrepreneurial projects and keeping your business operational.
- Personal loans can be used for funding business projects as well as paying for personal expenses.
- Business loans typically allow repayment over a longer period of time, while personal loans are more short term.
- Business loans offer more capital with a lower interest rate, while personal loans offer a smaller amount of money with a higher rate of interest.
What’s the Difference Between Business and Personal Loans?
Perhaps the biggest difference between business loans and personal loans is how you can use them. Business loans, for example, can help you pay for most business-related expenses, such as purchasing supplies, repairing machinery, payroll, and other operational expenses.
Personal loans, on the other hand, offer more flexibility in that they can not only be used for certain business expenses, but also for more private purposes that may only be indirectly related to the business. For example, buying a house close to your workspace isn’t necessarily a “direct” business expense, but it can improve the efficiency of your work.
Business Loans and Personal Loans at a Glance
The table below outlines some key differences between business and personal loans.
|Differences||Business Loan||Personal Loan|
|Use of capital||Business loans can be used to fund direct business expenses, such as stocking inventory, supplies, paying manufacturers, etc.||Personal loans can be used to fund both direct business expenses, such as startup funding and indirect lifestyle expenses like buying a house near the workspace, purchasing a car, etc.|
|Tax deduction||Interest paid on business loans may be tax-deductible based on local laws.||Personal loans aren’t tax-deductible since they’re not considered income.|
|Term||Business loans can be repaid over a longer period of time.||Personal loans have to be paid back quicker.|
|Amount||Less than $50,000 up to $5 million||$1,000 - $100,000|
|Collateral||Business loans are secured with collateral.||Most personal loans don’t need collateral.|
Purpose of the Loan
Business loans are useful for paying off business expenses such as supplies and materials. Personal loans can be used for business expenses as well as personal lifestyle-related payments.
Theoretically, you can use a personal loan to pay off business expenses. However, this may not be ideal because lending limits for personal loans are typically lower and interest rates are higher depending on your credit.
Depending on your state laws, qualifying business expenses can be tax-exempt or tax-deductible. Personal loans are very rarely, if at all, tax-deductible.
Nowadays, you can get both short-term and long-term personal and business loans, but typically, personal loans tend to have a shorter term, ranging from a few months to a few years (as the lending limit is also lower). On the other hand, the term for business loans can range from two years to even 10 to 20 years depending on your industry.
Terms for business loans provided by the U.S Small Business Administration (SBA) include 10 years for working capital or inventory loans, 10 years for equipment, and 25 years for real estate.
Personal loan amounts typically range from $1,000 to $50,000 (and even $100,000 in some cases). Business loans, meanwhile, vary even more as financial institutions like Bank of America offer loans starting at $25,000 while the SBA offers loans ranging from less than $50,000 to up to $5 million.
When choosing between a business loan and a personal loan, here are some important considerations to keep in mind.
When you’re opting for a business loan, lenders will check your business credit history, so it’s important to have a good business credit score. There are several free and paid tools available to check your business credit score eligibility. Similarly, when applying for a personal loan, your personal credit history is considered.
Second, consider how much capital you need before choosing between a business and a personal loan. Business loans can offer a large sum because the lending limits are much higher compared to personal loans. On the other hand, if you need a small amount of money to fund a side project or cover short-term costs, a personal loan may be a better option for you.
Which Is Best for Your Business?
When choosing between personal and small business loans and which lender to go with, the factors to consider are your business’s financial history, your business and personal credit score, and your business objectives in the near future. This will help you build a complete picture to understand which type of loan would work best for your situation.
Here are some common business situations and the suggested types of loans to handle them:
- If you have an established company and want to build your business credit score, consider taking a short- to mid-term business loan and pay it off quickly to boost your business credit score.
- If you have a poor business credit score but a good personal credit score, think about getting a personal loan since your personal financial history is strong. This way, you could be approved for bigger loans with better terms.
- If you don’t have collateral or don’t want to use it for loans, personal loans may be a viable option because most traditional lenders don’t require collateral for offering short-term personal loans.
Business Loan vs. Personal Loan Example
If you take a business loan, you would have lower interest rates; have to show collateral; have a longer time period to pay the money back; and get possible tax deductions.
If you take a personal loan, you would have higher interest rates; there would be no need for collateral; you would have shorter time periods for repayment; and get little to no tax deductions.
Alternatives to Debt Financing
While business and personal loans can be great ways to fund your business, they aren’t your only options. Today, entrepreneurs can choose from alternative methods of small business financing to keep their businesses running. Here are a couple to consider.
Organizations such as the SBA offer multiple grants for eligible entrepreneurs to funnel money back into the community. These don’t have to be paid back, so there’s no interest and debt.
If your business is centered around scientific research and development, you can apply for federal grants under the Small Business Innovation Research (SBIR) and the Small Business Technology Transfer (STTR) programs.
If you are open to the idea of offering equity in your company to investors in exchange for capital, you can avoid paying huge interest to loan lenders. There are investors willing to fund small business projects in exchange for equity and provide ample financial support, resources, and hands-on guidance so both parties can benefit.
Frequently Asked Questions (FAQs)
How do you get a loan?
Small business owners can apply for a loan directly through the SBA website, find lenders online, or apply for a traditional loan through their bank. There will be a brief process of inquiry and you may be asked for collateral. After this, your application may or may not be approved for a loan
How do you calculate interest on a loan?
It’s always best to talk directly with your lenders and financial advisors to clarify interest rates and loan payments. However, you can also use a loan calculator to calculate interest.
How do you get a loan with no credit or bad credit?
If you are unable to get a loan because of a poor credit score, consider taking smaller loans you can pay off quickly to boost your credit score. If you are in urgent need of cash, consider taking a loan with a co-applicant or applying for a business line of credit.
How do I check the status of my SBA loan?
You can check the status of your SBA loan directly through the agency’s online portal. The website features regular updates and offers multiple resources to understand the process and track your loans.