Starting a business takes time, patience and planning. Most new owners learn that it takes more money than they expected, too. Deciding how to pay for everything is a big decision. Business loans and personal loans are among the most common ways to finance a new company, and, while they’re often used interchangeably, there are reasons to pick one or the other.
CNBC Select asked financial expert Ashley Russo when it’s the right time to use a personal loan for your startup, when it can hurt and when a business loan is the better route.
Personal Loans
A personal loan is a form of credit that people generally take out for a large purchase. It can be used to cover a variety of expenses, from renovating a home to paying for a wedding, funeral or to move. Some people take one out to cover an emergency expense, as well.
Lenders usually ask how you plan to spend the money, but there’s no one set rule for how to use it. One option is to consolidate multiple credit card debts into one personal loan, for instance.
Interest rates on personal loans tend to be lower than credit cards, so a personal loan can save money if you need it. The average annual percentage rate (or APR) on a personal loan over two years is 9.58%, according to the Federal Reserve. For comparison, the average credit card APR is 16.30%.
The main factor on the rate you get on a personal loan is your credit score. Lenders have varying credit score requirements and better scores usually get you more favorable terms, such as a lower rate. When deciding whether to use a personal loan for your new business, keep in mind how much your credit score will impact your rate.
Another personal loan factor to consider is repayment term, or how long you’ll take to pay it off. Some can be repaid within a few months, others extend to a few years. There may also be fees, such as origination fees and prepayment penalties, which can add to the cost of the loan. Discover Personal Loans does not charge an origination fee.
A Loan for a Small Business
A small business loan is exactly that: a loan for a small business. It can cover costs involved in running a business. The money can come from different places. You can get one through the SBA, a government agency. Commercial and community banks offer them, too, as do peer-to-peer lenders (like Funding Circle) and online lenders (such as Kabbage).
There are many kinds of business loans and each one is generally more suitable for a particular need. A line of credit works just like a credit card. You’re able to borrow up to a certain limit and pay interest only on the money you withdraw. Another popular loan is working capital, and it’s usually used to pay routine costs such as payroll or office rent. Other types of loans are even available that can better fit your need.
You Can Use a Personal Loan
When it comes down to it, yes, you can use a personal loan to pay for the expenses of starting a small business. But using one has consequences for your personal finances, so it’s better to be careful.
You could use it for inventory, payroll or rent. However, you should find the lowest interest rate you can, says financial planner and educator Ashley Russo.
Both personal loans and business loans are a fine way to pay the costs of a new business. Which is better for you depends on a variety of factors, including your credit score and how much money you’ll need. Here are some reasons why you might choose one over the other.
Getting a business loan may involve extra paperwork, since some small business lenders will want to see business documents before approving you.
Banks, for example, may want business tax returns, copies of recent pay stubs and maybe even a business plan. You may not be able to show that if your business is new, which is OK because a personal loan doesn’t need that proof.
If you’re unsure whether business use is permitted under a personal loan, ask your lender. Being upfront is always the better option. Some lenders have terms that say if the loan was used for a purpose not approved, then they can demand payment in full (with interest) immediately.
Some small business lenders require you to put up collateral (your car, home or inventory) before they give you a loan. With a secured loan, the lender can take the asset if you fail to make payments. A personal loan is usually unsecured, which could make it a good option if you don’t have any collateral.
How much you need to borrow is a big question. Most SBA loans allow up to $5 million, but most personal loan lenders go up to $100,000. Keep this in mind when choosing which of these two sources to turn to for a loan.
If you need more than $100,000 to start your business, an SBA loan may be the better route to take. If you’re not sure how much money you actually need, create a business plan and a budget that outlines your expenses. It can help you determine how much money you need.
Also keep in mind that a personal loan is credit issued in your own name, based on your credit history. If you fall behind on your personal loan, it can ding your credit score. That means a credit card, car loan or mortgage might be harder to get in the future.
In the end, where you get the money and what works best depends on your situation, such as how much money you need, where you’re likely to get the lowest interest rate, and how much risk you’re comfortable taking with your personal credit.
Before you apply for a loan, check that business use is allowed under the loan terms. You can also prepare a business plan and budget that spells out how you plan to use the money.
Before you borrow, you should know where you are beginning from, what revenue the business will bring in and how you will pay the money back.
About Delancey Street
Delancey Street is a premier, and award winning, business debt settlement company that helps business owners nationwide. Our goal is simple: help you escape debt in a safe and legal manner. Based out of New York, we can help in 49 of 50 states. We tell you how it is; because your business and future is on the line.
