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Starting a small business is not an easy task. They require a ton of time, patience, planning, and often way more money than you bargained for. Fortunately, there are financing options that aspiring small business owners can turn to. Two of the most common are small business loans and personal loans. And while they may seem very similar and virtually interchangeable, there are actually some very important reasons why you might want to choose one over the other.
Select spoke to a financial expert Ashley Russo to failure when it may (and may not) be beneficial to take out a personal loan to start your small business.
What is a personal loan?
A A personal loan is a line of credit generally used for major purchases. Just as its name suggests, a personal loan is staff, meaning it can be used to cover the cost of anything important to your personal situation. These can be home renovations, wedding, funeral expenses, moving expenses, emergency expenses, etc.
There really isn’t a hard and fast rule as to how the loan will be used (however, you will usually need to explain your plan for using the money when you apply for the loan). You can even use it to pay off multiple credit card debts – this way you can essentially “consolidate” your credit card debts into one personal loan that you will pay off.
Personal loans generally carry a much lower interest rate than credit cards. For reference, the current average APR for a two-year personal loan is 9.58% while the average APR for a credit card is 16.30%, according to the Federal Reserve.
In most cases, the interest rate you will be charged will depend on your credit score. And although 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 longer loan repayment terms. favorable.
Another important distinction is that personal loans usually have a set repayment period. It can range from a few months to a few years. And depending on the lender, you may be charged a fee if you repay the loan early., before the end of the repayment period. Some lenders will also charge origination fees, but if you want to avoid this, you can exclusively search for loans without, such as the Discover the personal loan.
For a better idea of the other personal loans available, you can check out our list of the best personal loans.
Annual Percentage Rate (APR)
Purpose of the loan
Debt consolidation, home improvement, wedding or vacation
A small business loan is similar to a personal loan, but is intended to help entrepreneurs obtain financing for a variety of costs related to running their business. Some of these loans can be applied for through the United States Small Business Administration (SBA), but you can also apply for small business loans from commercial banks, community banks, peer-to-peer lenders as Funding Circleand online lenders like Cabbage.
There are also different types of business loans. A small business line of credit gives you a certain amount of credit that you can withdraw and receive in cash, and you’ll pay interest on what you’ve borrowed (much like you would with a credit card). And working capital loans are meant to help cover the day-to-day costs of running your business, like payroll and rent for your office or workspace. These are just two types of loans to consider, but there are also other types of business loans that might suit your needs better.
The short answer is yes, a personal loan can also be used to cover expenses associated with starting a small business.
“Once you’re approved for a personal loan, you can use it however you see fit,” said Ashley Russo, financial planner and educator. “If you’re starting a small business, you can use the personal loan to cover anything from inventory to payroll to rent. But you might consider doing it at the lowest possible cost to you. , which means taking out the loan with the lowest possible interest rate.”
When does it make sense to use a personal loan for my small business?
So now you have two very good options for financing your small business. But there are a few things to consider when determining which type of loan is right for you.
Keep in mind that when you go to apply for a small business loan, some lenders may ask you for a few business-related documents before you can be approved.
“Some banks will require tax returns or pay stubs for your business, or they might ask you to provide a business plan,” Russo said. “With personal loans, on the other hand, you don’t have to show a business interest to be approved for a loan.”
But before applying for a personal loan, you need to make sure that the lender has no restrictions on using the money for business purposes. If the terms of the personal loan are unclear, you need to be honest about your intentions as a borrower and make sure the lender knows you can use the money for your business.
You can simply ask the lender if you can use the personal loan for business purposes. It’s best to be upfront about your intentions to make sure you don’t violate any loan terms; Using a loan for prohibited purposes could result in the lender requiring you to immediately repay the full amount plus interest.
Also, if you don’t have any collateral that can be used to secure your business loan, you can opt for a unsecured personal loan. A secured loan means that if you don’t make payments, the lender can seize an asset (your car, your house or, in small business terms, it could be your inventory) that you have provided as collateral. Some small business lenders will require you to secure the loan with an asset, whereas personal loans are generally unsecured.
Another thing to consider is the amount of money you plan to borrow. More SBA Loans allow you to borrow up to $5 million for business expenses. Most personal lenders will approve you for up to $100,000.
When might it make sense to apply for a small business loan?
Limits on the amount you are allowed to borrow for each loan are a very important consideration. If you think you need more than $100,000 to start, you may want to consider applying for an SBA loan as they have higher maximums. Creating a business plan and budget can help you identify your exact needs.
Also, remember that personal loans are tied to your personal credit history. Thus, if you are late in payment, your personal account your credit score may suffer, which can make it harder to get approved for other lines of credit like a new credit card, car loan, or mortgage.
Personal loans and small business loans are effective ways to cover the expenses needed to start your small business. Your choice may come down to how much money you actually 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 beforehand to ensure that you can use the loan for business purposes; if it’s not clear, you should ask the lender directly. Also, be sure to spend time developing a business plan and budget that can help clarify your needs.
“It’s hard to know where you’re going if you don’t know where you are,” Russo said. “When creating your business plan, determine your income expectations and know how you will repay the loan before you even apply.”
Editorial note: Any opinions, analyses, criticisms or recommendations expressed in this article are those of Select’s editorial staff only and have not been reviewed, endorsed or otherwise endorsed by any third party.