Breaking Down Business and Personal Loans: What Are the Differences?
* The article was initially published on our blog.
In this article, Armada Labs compares loan options in business and personal funding to help small businesses choose the right one for their operation.
No doubt, your business might need a loan for plenty of reasons, like sales spikes causing a need for additional cash flows or conditioning a need for expansion. Well, you might say that a business loan would be the obvious choice in such cases, but everything is straightforward only on the surface.
Conversely, many small businesses often tend to choose personal loans over business ones for their relative simplicity in use. But should the ease of application be the only driving factor when considering options? Of course, not, and today, we will prove it to you by comparing business and personal loans in every crucial aspect.
Business Loans vs. Personal Loans: Step-by-step Comparison
Using our extensive expertise delivering custom loan management solutions for businesses across various verticals, we thoroughly matched both loan types, and here’s what we found.
Annual Interest Rates
When providing business loans, lenders might or might not charge annual interest rates from you. Some opt for monthly fees and feel just fine with those. Of course, both cases involve loans at a fixed rate that might be as low as 5,5%.
Personal loans offer more freedom, with fixed and variable interest options available. Mind that variable interest loans usually have a lower starting rate than that of fixed ones, with some businesses offering as low as 3,99% at the start. More, a low interest rate might remain as such throughout the whole loan term.
Loan Duration
Business loans can be long-term and short-term, and you can either opt for invoice financing for just a month or repay borrowed funds for up to 25 years by taking SBA loans. Personal loans, in turn, usually vary from 1 to 7 years in duration.
Acceptance Criteria
Lenders who provide business loans pose more strict requirements than in the case with personal ones. To obtain the business loan, your business should operate for at least a year, with a minimum monthly revenue of $10,000.
When applying for the personal loan, you need to have at least a good credit, and there are no requirements for the duration of your operational activity. Yet mind that lenders might also evaluate your income and debt-to-income ratio.
Joint Usage
If you have partners and apply for the business loan, then you must hold the loan on a business account where all involved parties can easily access it. Each party is equally responsible for repayment, hence the risk carried by an individual is low.
In the case of the personal loan, a lack of joint access to the company’s credit will raise questions of responsibility for repayments if the company becomes insolvent. Yet joint applications are possible here, with two applicants allowed (however, some companies might allow more applicants).
Both applicants need to meet the set criteria collectively. Plus, the lender might consider combined income instead of individual one when underwriting the application, which is convenient for all parties that apply for the loan.
Ease of Application
Whether you need the business or personal loan, loan claiming might be a long process. Or it might not, again, depending on the type of loan you need.
For the former, lenders might require you to provide a business plan and accounting reports along with the application. Also, some banks need business owners to apply for loans in person, so be ready for such request. At any rate, banks might be thorough in their requirements to make sure your business is creditworthy and able to make repayments throughout the loan period.
Yet that might not be the case for personal loans, where typically, you need to fill in an online form (some banks might require proof of income and tax return history for the last two years if you are self-employed) and even get a pre-approval from some lenders.
Pre-approval is an unofficial loan offer pending full approval. That document confirms that you meet basic loan eligibility requirements and indicates loan amount, rates, and other conditions for which you might qualify.
However, remember that pre-approvals don’t guarantee you funding. Lenders might reject your loan application for various reasons, which might include their inability to validate your income because of improper documents from your part, low credit score, too many inquiries on your credit report, and others.
Thus, whether the pre-approval is provided or not, make sure your loan application is accurate and consistent, and your business is in a position to repay.
Flexibility
Lenders of business loans are likely to put strict limitations in the first 12 months of the loan, but if you demonstrate your solvency during that period, you can count on an increase in funding. And, of course, you must use the entire amount of the loan solely on business purposes.
However, personal loans are more flexible in this regard; you can negotiate more funding sums with the lender in the first place, but be ready to pay a certain amount of the existing loan for that. Since these loans are personal, you might also use them for purposes other than business-related.
Business and Personal Loans: Which Ones Meet your Challenges?
As we can see, personal loans might be the best of the two options when it comes to interest rates, acceptance criteria, and ease of application. Also, they are more flexible in terms of joint usage and implementation.
When can you use a personal loan? Well, the purposes might vary from debt consolidation and event financing to purchase of a property. Lenders usually offer loans ranging from $1,000 to $10,000 in amount, yet some provide options of even $100,000 per loan.
Need that high amount for your venture? Then make sure your credit score is impeccable, and your revenue is stable. And if you decided to use a loan to back your business, beware of the risk: if you default, the lender might forfeit your assets rather than operating profits.
Speaking of business loans, those are meant for business purposes only, like getting invoice advances or purchasing equipment. Mind that lenders might expect a detailed business plan from you describing the intentions of using the loan.
Can you use business loans for personal expenses? Yes, you can, but it’s not recommended; instead, keep your business and personal expenses separate to make their tracking easier for yourself and facilitate reporting to IRS about different sources of revenue. Also, your loan contract itself might prohibit using funds for purposes other than business-related.
To conclude, we will list the possible use cases for personal and business loans. So, opt for the personal loan if:
- Your business is new, and you don’t have a sufficient credit yet;
- You have an excellent credit for which you might get the loan at a lower rate;
- You need quick funding;
- You need the loan for both personal and business purposes.
What about business loans, then? Choose that option if:
- Your business has a credible financial history;
- You want to establish a relationship with the lender;
- You need to back up specific expenses in your operation;
- You have collateral for the loan.
Not sure what type of loan to request? Ask Armada Labs! Contact us, and we will consult you on the loan that works best for your business goals.
