Starting your own business, especially when doing so after freelancing for quite some time, can mean having a difficult road ahead of you. This is particularly true when finding sources for financing your venture.
Some people can utilize their own savings and personal finances to fund their business, while others might need to apply for loans to start a business.
Although most people can apply for a business loan, the application process can be more stringent than applying for a personal loan. For this reason, many entrepreneurs think of applying for a personal loan and using those funds to finance their startup.
However, can you use a personal loan for business? Even more important, should you?
You definitely can use a personal loan for business. However, it is not a secret workaround, and some downsides come with this financing option.
What is a Personal Loan?
Personal loans are loans that most individuals use to pay for personal purposes, such as paying off credit card debt, financing home improvement projects, or paying for unexpected expenses like hospital bills.
These are flexible loans since they come with few restrictions, unlike specialized financing options like mortgages and auto loans.
As such, personal loans are popular among those who require additional financial assistance to fund expenses. You can use the funds as you want, so there is really no reason why you can’t use a personal loan for business purposes.
Personal loans can be a great option for starting your business, especially when you’re a freelancer. Lenders can look at your personal financial information instead of your business income, making personal loans much easier to obtain as long as you have a solid financial history.
What is a Business Loan?
As the name suggests, business loans are used to fund business-related transactions, such as starting your own business, expanding, or paying for merchandise. However, applying for a loan for your business can be difficult because the requirements and application process are stricter than when applying for a personal loan.
And I’m not talking about large, multimillion-dollar deals. Even small business loans can be difficult to obtain.
Lenders will want to see:
- Financial statements (income, balance sheet, cash flow statement, etc.)
- Bank statements
- Financial projections for the next few years
- Tax returns
- Outstanding debt and monthly obligations like your mortgage/lease
Because personal loans have a limit, getting a business loan can be beneficial if you’re seeking to borrow large amounts of money and want a long repayment period.
Can You Use a Personal Loan for Business?
Every entrepreneur has asked this question, and yes, you can.
However, when it comes to using a personal loan for business, there are certain considerations to take. Sure, you can get quick cash with little hassle, but what disadvantages come with personal loans?
Instead of asking yourself if you can use a personal loan for business, think about if you should use this type of funding.
Using a Personal Loan for Business
As a freelancer, it’s easier to qualify for a personal loan than a business loan.
Many lenders, like banks, credit unions, or even non-traditional business lenders, tend to prefer already established businesses. If you are a 1099 worker or have a small LLC, it might be hard to show your business’s solid financial history.
Because of this, freelancers can opt to apply for a personal loan and use the funds to finance their affairs. The cash can be used to hire extra help, pay for advertisements, rent out an office, or buy new computers.
Let’s take a closer look at the various pros and cons of doing so.
Easier to Obtain than Business Loans
As mentioned, when applying for a personal loan, the lenders would only be checking out your personal assets and personal credit score, rather than your business’s. Because of this, personal loans are easier to obtain than business loans.
Business lenders tend to examine both your personal and business financial history; therefore, it can be difficult to meet the latter requirement if you’re only starting. It’s even more difficult with freelancers since your personal and business taxes are often filed together.
As such, business lenders can see this as a huge risk since the line between your business finances and personal finances are not clear.
No Need for Collateral
Personal loans are typically unsecured. This means you don’t need to put up collateral to qualify for the loan. Business loans typically require collateral for you to qualify for one, even for small amounts sometimes.
Opting for a personal loan is wise if you don’t want to lose your own personal assets in case your business doesn’t succeed. You’ll also have some time to gather more funding to pay off the loan in case it doesn’t work out.
Allows You to Test Out Business Concepts
With a personal loan, you can try new ideas on a small scale to see if they work. It’s smart to start small like this, especially if you’re still getting the hang of running your own business.
You will reduce your overall risk by refining your approach until it can turn a profit at the micro level. Once you see success, you can inject more capital into your business and scale-up.
For example, you might be a digital marketer who wants to sign up more clients. You can borrow a small amount to run ads on Google and other networks. During this time, you can tweak your ad copy until you start to see repeat success.
As your leads increase and you convert more clients, you can increase your ad spend and onboard even more clients.
Interest Rates are Higher; Lending Limits are Lower
One of the biggest drawbacks you’ll see is that personal loans tend to have higher interest rates than business loans.
If your credit score is less than excellent or if you have a low salary, your interest rate may be higher than desired. As such, it can eat up a significant amount of any revenue your fledgling business might produce.
Also, you will not be able to borrow as much cash with a personal loan. Even if you have a perfect credit score, banks will not want to offer a huge line of credit without business collateral.
Higher Risk for Your Personal Credit
When using a personal loan for business purposes, you’re putting your own credit on the line. While this can make it easier to obtain the loan, you need to be sure you can repay the debt.
If not, your credit score can drop severely, causing future lenders to be concerned about your creditworthiness. It will be harder to obtain financing on things like homes and cars in the future, and you will likely have lower limits and higher interest rates.
Denying Your Business to Build Its Own Credit History
While personal loans can be good if you’re a small startup, using this kind of loan to fund your business can impede growth. It might make it more difficult to gain additional financing later on when your business expands and requires more funding.
After all, some of the establishments that offer loans will look at your business’s credit score when determining whether or not it’s eligible for a business loan. Your personal loan won’t necessarily hurt your business, but it does prevent it from standing out on its own.
Personal Loan vs. Business Loan: Which One Should You Get?
When starting a business or expanding your freelance services, it makes sense to start with a personal loan to fund your venture. Solo entrepreneurs tend to have much lower operating expenses and may only need a few thousand dollars to accomplish their goals.
However, you cannot rush into this without thinking about the consequences.
When is it better to use a personal loan or a business loan to fund your business?
Personal Loans Make Sense When:
- Your business is fairly new and doesn’t have a strong credit history yet.
- You don’t have any collateral to offer.
- You need money right away.
Business Loans Make Sense When:
- You need a large amount to fund your venture.
- You want to build your business credit to accommodate future growth.
- You don’t want to jeopardize your personal credit rating
Best Lenders for Personal Loans
Online lenders are a dime a dozen, and choosing the wrong option can come with high costs and tons of stress.
To help you find a trustworthy, accredited lender, I’ve done my research to find the best places for personal loans.
- Best for comparing rates: SuperMoney lets you borrow up to $100,000 and see get offers in seconds. If you want to know all your options, choose SuperMoney Personal Loans
- Best for good to excellent credit: You worked hard for your credit score, so you deserve great rates. Even Financial analyzes current offers from top lenders to match you with the best offers. You can get up to $100,000 with Even Financial Personal Loans
- Best for low to okay credit: SmarterLoan.com offers fast loans from $500 to $10,000, and all credit types are accepted. Loans available for nearly any purpose. Get started now!
Starting a business is no easy feat, especially when it comes to finding financing. While you can apply for a business loan to fund your venture, the stringent requirements can be difficult to meet, especially as a freelancer.
There are advantages and disadvantages to using personal loans for business – you just need to weigh whether or not it’s the most suitable way to fund your venture.
I have been a freelance digital marketer since 2014, specializing in content marketing and editing. My interest in finance and frugal living began while living overseas, inspiring me to start this blog. When I am not helping clients generate more leads or market their services, I explore the world, listen to podcasts, and dream big.