We may all find ourselves needing extra funds at one time or another, whether it’s for personal or business expenses.
Getting a loan from a bank, credit union, or other financial institution is a common way to acquire needed funds.
But are business loans and personal loans the same?
- Do they have the same requirements?
- Do you need to have a good credit score?
- Are the interest rates the same?
How can you know which type of loan best suits your needs?
In this guide, we’ll define personal and business loans, discuss the advantages and disadvantages of both, and provide you with some steps to apply for the loan of your choice.
Personal Loans and Business Loans Defined
A personal loan is a type of unsecured loan that provides individuals with a fixed amount of money at a fixed interest rate and repayment term.
It can be used for various purposes, such as:
- Paying off debt
- Making a big purchase; or
- Covering unexpected expenses
Personal loans are offered by banks, credit unions, and online lenders.
A business loan is a type of loan specifically designed for business owners to finance their company's operations, growth, or investment needs. It is typically secured or unsecured and can be obtained from a bank, financial institution, or alternative lender.
Business loans can be used for various purposes, including:
- Purchasing equipment
- Expanding operations; or
- Refinancing existing debt
Personal Loan vs. Small Business Loan: How Do They Compare?
Though personal and business loans have similarities, their differences are more evident. Knowing those differences is key when choosing a loan for your particular needs.
The most common differences between business and personal loans concern:
- Interest rates
- Repayment terms
- Eligibility requirements
- Collateral; and
- Credit scores
Personal loans tend to have higher interest rates than business loans and are determined by the lender based on the borrower's:
- Credit score
- Income; and
- Financial history
Interest rates can range from as low as 4% to as high as 36%, depending on the lender and the borrower's qualifications.
Business loans often come with variable or fixed interest rates, depending on the lender and loan type. The interest rate depends on factors such as the business's:
- Credit history
- Cash flow
- Purpose of the loan; and
For both personal and business loans, it's important to compare interest rates from multiple lenders. Consider the total cost of the loan, including fees and repayment terms, before making a decision.
Personal loans typically have shorter repayment terms than business loans.
Repayment terms for personal loans typically range from 1 to 7 years, with the length of the term affecting the monthly payment amount.
Repayment terms for business loans can vary widely, depending on the lender and type of loan. They typically range from 1 to 25 years, with shorter terms often associated with higher monthly payments and longer terms having lower monthly payments but a higher overall cost.
The eligibility requirements for business and personal loans can differ significantly.
For a business loan, lenders typically require the business to have:
- Been in operation for a certain period of time
- A minimum level of annual revenue
- A solid business plan; and
- A good credit history
Personal loans typically have less strict eligibility criteria than business loans. Personal loan eligibility requirements are generally based on the individual's:
- Credit score
- Income; and
- Debt-to-income ratio
Whether a business or personal loan requires collateral depends on the lender and the loan type.
Business loans often require collateral, such as …
- Real estate; or
… as a way of securing the loan. This can increase the chances of approval but also means that the business assets can be seized if the loan is not repaid.
Personal loans, on the other hand, are typically unsecured, meaning they do not require collateral. They may, however, require a co-signer.
A credit score is a numerical representation of a person or business's creditworthiness and reflects their past borrowing and payment history. Maintaining a good credit score is important for businesses and individuals seeking loans.
Generally, personal loans will be based on the borrower's credit score, while business loans will be based on the business's creditworthiness.
A higher credit score typically results in a lower interest rate, while a lower score may result in a higher rate. A strong credit score can increase the chances of approval and result in larger loan amounts.
Advantages and Disadvantages of Personal Loans
Personal loans offer the following advantages:
- Accessibility - Personal loans offer flexible financing options without requiring collateral or having a specific use restriction.
- Easy budgeting - Personal loans offer a fixed interest rate and a set repayment term, making it easier for borrowers to budget and plan their finances.
- Multiple uses - Personal loans can be used for a variety of purposes, including debt consolidation, home improvements, or medical expenses.
- Better credit scores - Personal loans can help improve credit scores by demonstrating the borrower's ability to repay the debt on time.
Personal loans have some disadvantages that borrowers should be aware of:
- Higher interest rates - compared to other forms of credit, personal loans can have higher interest rates, resulting in a higher overall cost of borrowing.
- Personal liability - Personal loans have strict repayment terms, and missing a payment can result in additional fees and damage to the borrower's credit score
- Approval process - The approval process for personal loans can be time-consuming and may not always result in the loan being approved.
Advantages and Disadvantages of Business Loans
Business loans offer several advantages for small businesses:
Lower interest rates - A business loan can offer a fixed interest rate and a set repayment term, making budgeting and financial planning easier.
Improved cash flow - Business loans can help improve cash flow and provide stability for the business.
Better terms - Some business loans, such as SBA loans, may offer favorable terms, including lower interest rates and longer repayment periods, making it easier for small businesses to repay the loan.
Dedicated funding for business expenses - Business loans provide access to capital for expanding operations, purchasing equipment, or covering unexpected expenses.
Business loans also come with some important disadvantages to consider:
- High cost - Business loans can have high interest rates, origination fees, and closing costs, making them more expensive compared to other forms of financing.
- Strict Requirements - Obtaining a business loan may require a lot of documentation, such as financial statements and business plans, making the process time-consuming and difficult for some businesses.
- Repayment Terms - Business loans often have strict repayment terms, with penalties for late or missed payments, which can be a significant burden for small businesses.
- Risk of Collateral Loss - Many business loans require collateral, such as property or equipment, which can be seized by the lender if the loan is not repaid.
Small Business Loan vs Personal Loan: How To Decide Which Loan Is Right for You
Factors To Consider
When deciding which type of loan is the best for your needs, you should consider the factors discussed above:
- Eligibility requirements/credit score: A business loan will probably require a good credit score and financial documentation. On the other hand, you may have an easier time getting a personal loan with a lower credit score.
- Interest rates: Business loans usually have lower interest rates than personal loans.
- Repayment terms: How long do you need to repay the loan? If you need a longer repayment agreement, a business loan may be the way to go.
- Collateral: If you don’t have acceptable collateral, a personal loan may be the best option.
In addition to these factors, the following additional factors may also help you decide on the loan option best for your needs:
- Tax benefits: Business loans may have tax benefits, such as being able to deduct interest payments from the business income. Personal loans do not have the same tax benefits.
- Potential for personal liability: Business loans can put the borrower's personal assets at risk in case of default. Personal loans, on the other hand, only put the loan amount at risk.
- Flexibility: Personal loans are more flexible than business loans in terms of how the funds can be used. Business loans often have specific restrictions on how the funds can be used.
- Fast approval: Personal loans are generally approved faster than business loans, as they are less complicated to process.
How To Apply for a Business or Personal Loan
Whether you’re applying for a business loan or a personal loan, the application process is essentially the same.
Follow these steps to apply for a loan:
- Prepare your financial documents: For a business loan, you’ll typically need your business tax returns, financial statements, and cash flow projections.
For a personal loan, you’ll need certain documents, such as proof of income, identification, and bank statements, that will be required by the lender.
- Determine the type of loan you need or how much you need to borrow: Business loan options may include term loans, lines of credit, SBA loans, and merchant cash advances.
For a personal loan, consider how much you need to borrow and what you will use the loan for. Remember to review your credit score and credit report before applying for a personal loan to ensure that there are no errors that may affect your chances of getting a loan.
- Research lenders: Compare different lenders and their loan products, interest rates, and terms. Look for lenders that specialize in your industry or have experience lending to businesses like yours.
For personal loans, research different lenders, including banks, credit unions, and online lenders, and compare their interest rates, fees, and loan terms.
- Fill out the loan application: Complete the loan application provided by the lender. For a business loan, be prepared to provide information about your business, its financials, and your personal financial information. For a personal loan, you may need to include information about yourself, your income, and your credit history
- Submit supporting documents: Submit all the required financial documents and any other supporting documents requested by the lender.
- Wait for approval: Wait for the lender to review your application and make a decision. This process can take several days to weeks, depending on the lender and type of loan.
- Review and negotiate the loan terms: Once you have received a loan offer, review the terms carefully and negotiate any terms that you disagree with.
- Sign the loan agreement: Once you have agreed to the loan terms, sign the loan agreement and return it to the lender.
Use the funds: Once the loan is approved, you will receive the funds. Use the funds as intended, and begin making the loan payments according to the agreed terms.