Business Loans vs. Personal Loans: How They Compare

Are you looking for the necessary capital to actualise that great business idea you have been brainstorming for the last while? Or is it time to level up your existing business and maybe open another branch? 

If that is the case, you’ll want to consider taking a loan among the options available to you. But what type of a loan exactly? 

In general, you could apply for a personal loan or a business loan, depending on your business situation. But keep in mind that both types of loans have their own unique requirements. For example, some lenders will require you to provide audited financial statements for the previous three years to qualify for a business loan for a business older than five years.

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Hence, to decide the best type of loan for your needs, you need to check what you qualify for in your current situation. In addition, you need to consider the benefits and potential drawbacks of each type of loan. 

Some loans have precise requirements, while others need you to jump through hoops to qualify. For example, if you need a quick top-up while ordering new stock for your shop, a quick request on your mobile (digital loans) can easily save the day. On the other hand, if you need full financing for your business idea, you might need a lot more than a digital loan. 

This article will break down the differences between personal loans and business loans to help you better determine which best suits your needs. 

Personal Loans

Characteristics

Personal loans are available to individuals. Many personal loans are not secured against an asset (unsecured loans), but depending on the amount, your credit history and the lender, you may need to take a secured personal loan.

Unlike business loans which are limited to a specific business purpose, personal loans are more flexible. You can take a personal loan for business as well as for more private purposes. 

Unsecured personal loans are based on your personal financial history (your income and your credit history). The loan is issued with the promise to pay back over a specific set period in fixed monthly repayments.

What can a personal loan be used for?

One of the main advantages of a personal loan is that it is versatile and can be used for anything - based on your individual needs. 

Although the lender might request details of the funds’ usage, there is typically no restriction to what you can spend the money on. However, some lenders may still have restrictions on their loans. Therefore, it is advisable to read the fine print on the loan contract carefully. 

Can I use a personal loan for business?

Absolutely! You can use a personal loan for business expenses. However, keep in mind that if the business cannot pay back the loan, you are personally liable for the debt - your personal assets may be seized/liquidated to recover the outstanding amount. 

Pros and Cons

Advantages and disadvantages of using a personal loan for business

Advantages

• Easier and faster approval process. Compared to a business loan, personal loans have a pretty straightforward approval process if you have the required qualifications compared to a business loan. It might be the best option, especially if you haven’t been in business for long. 
  

• No collateral. Unlike business loans, most personal loans do not need you to surrender collateral before approval.  
  

• Flexibility and versatility. Most business loans are limited to specific purposes. For example, if you took out a business loan to buy a business vehicle, you can only use the money to purchase a vehicle. Most personal loans do not have this limitation. You can use a personal loan to pay rent, medical bills, etc. 

Disadvantages

• Higher cost borrowing. In many instances, the interest rate on a personal loan can be significantly higher than on business loans. This is especially the case if the loan is unsecured. Also, some personal loans can attract high fees and penalties driving up the cost of borrowing. For example, some personal loans have processing fees of up to 6%, and some lenders also charge penalties if you pay up the loan before the loan term. 
  

• Can damage your personal credit history. A personal loan is attached to your personal credit history. Therefore, if the business cannot repay the loan, you are liable for the debt, and your personal credit history is affected. 
  

• It is not tax-deductible. 

Personal loan vs. business loan rates

When applying for a loan, it is crucial to keep in mind that the interest and fees charged by the lenders will affect your cost of borrowing. Therefore, it is advisable to consider all the fees when deciding which option is best for you. 

Depending on the type of lender, amount borrowed, the interest structure and other lender-specific terms, a personal loan could have a higher total cost than a business loan and vice versa. 

Business Loans

Characteristics

Business loans are monies borrowed to finance working capital needs, new business projects, or general business expansion. In most cases, business loans come with restrictions regarding spending the money. 

Ideally, the money should only be spent on business endeavors to generate additional revenue to finance the loan repayment. 

To qualify for a business loan, you need:

• Proof of business existence
• Healthy business turnover
• Proof of healthy business cash flow
• Healthy credit (and repayment) history
• Most lenders require you to be in operation for at least six months
• The loan amount should be within the maximum business turnover

What Can  A Business Loan Be Used For

Although many lenders give restrictions on how the borrowed funds may be used, a business loan can be used for all business expenses that increase business turnover. 

This includes updating technology and equipment, purchasing business inventory, paying for rent on business premises, hiring human resources, marketing, and even covering your business overheads.

You can not use a business loan to pay for personal expenses. Although they do not necessarily monitor every transaction to see if it was used for business, the lender has the right to call in the balance of the loan and give a penalty if they find out that the money is used for other purposes. 

Advantages and Disadvantages of Business Loans

Advantages

• Separating personal and business liability. With a personal loan, you are fully liable for the debt. However, depending on your business legal structure, a business loan gives you the advantage of limited liability for the debt. 
• Larger Amounts. You can only get so much funds when applying for a personal loan. If you need a significant amount to fund a business milestone, you will likely need to consider a business loan instead. 
• Building a business credit record. As earlier mentioned, one of the eligibility requirements when applying for a business loan is a healthy credit and repayment history. Hence, taking a business loan instead of a personal loan will help you build a good business credit history. 
• Tax-deductible. Business loans are tax-deductible as a business expense. 

Disadvantages

• Not all businesses qualify for business loans. There are a lot of strict requirements when applying for a business loan. Not all businesses can meet the eligibility criteria set by the lenders. 
• Most are secured loans. Most business loans require collateral owned by the business. Smaller, younger businesses may not have assets to use as collateral. There is a risk of losing the asset in case of default. Many lenders, however, have loan products tailored for such businesses. 
• Lengthy application process. A business loan application will typically take longer than a personal loan to be processed. There is also considerably more documentation needed from the borrower before approval.

How to Choose Between a Business Loan and a Personal Loan

The above information shows that whether you choose to go the personal loan or business loan route depends on your business situation. Each case is unique.

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To determine which option is best for your business, you need to evaluate several factors. These factors include:

• The size of your business
• Your trading history (revenue and profits)
• The urgency of your money needs
• Whether the loan is secured or unsecured, etc
  

Here are some hypothetical business situations and suggested best loan options:

• If you have a business idea and your only option is to get a loan, you should consider taking a personal loan. Not many lenders will consider a new business for a business loan. Some lenders may, however, consider a business that has been operational for 3 months only.
• If you have an established business but do not have collateral or don’t want to use a business asset as collateral, you should consider a personal loan. 
• A business loan is the way to go if you have an established business with a good cash flow and an excellent credit history. 
  

Ultimately, whether it is a personal loan or a business loan that will save the day solely depends on the general situation of your business. Looking at your business’s individual circumstances and comparing them with different loan requirements will help you make the right decision.