Should you take out a personal loan for business? 5 questions to answer first

A simpler alternative

It seems like a no-brainer: If you can bootstrap your new business from the start, you’ll avoid going into expensive debt. But surprisingly, 29 percent of business owners wish they’d secured more funding — such as a larger personal loan for business — when they started, according to a 2016 survey from The Alternative Board.

For business owners looking to borrow, there are plenty of places to find funding.

 

Business loans, which are usually granted to companies with established credit and a plan for profitability, are a popular option. But young companies can find it hard to qualify.

Personal loans, on the other hand, can be obtained using your personal credit history. That can make them easier to get. While personal loans can be a great source of funding, taking one out isn’t the best choice for every business owner. To decide if using personal loans to fund your company’s expansion is a smart choice, answer these five questions.

1. Can you qualify for a personal loan for business?

Your personal loan for business can be a smart way to fund company growth, but not everyone is eligible for one. To qualify, you’ll need to have a good credit score and proof of stable income.

If your credit score is below 670, you’d be considered a subprime borrower by many lenders — and could have difficulty getting a loan.

If you have a good credit score but no income, financial institutions might also be wary of lending to you. That is, unless you can provide proof that you can afford your loan payments.

Asking a cosigner to take joint responsibility for a personal loan could help you get past these hurdles. However, since the cosigner would be responsible for paying back the loan if you can’t, you’d need to have a clear plan for repayment. You should also have a serious discussion with your cosigner about the risk they’re taking on.

To find out if a personal loan for business is a possibility, consider getting prequalified. When you do, you’ll get an idea of the loan repayment terms and interest rate you’ll be offered. You’ll need this information to decide if financing your company with a personal loan is affordable.

 Personal Loan for Business Risk

2. Can you borrow enough to make your company a success?

If you can take out a personal loan to grow your company, you’ll need to think about whether you should.

To make this decision, start by determining how much you need to borrow. If you don’t already have a detailed business plan, make one. Include projections on costs and when you expect to become profitable. A business plan can help you determine how much capital you require.

When you’re deciding on the size of your personal loan for business, be realistic about how long you might need funding before you turn a profit.

According to a study by CB Insights, running out of money is the second most-common reason startups fail. Twenty-nine percent of fledgling companies closed their doors when they ran out of money and weren’t able to continue operations.

You don’t want to borrow money only to go out of business before you see your plans through to fruition. If you can’t borrow enough (or you need to borrow way too much) to keep your doors open long enough to become profitable, you might need to explore other financing options.

3. What’re the advantages of using a personal loan for business?

Assuming you can borrow enough to fund your company’s growth, is a personal loan for business the best choice?

When compared with other popular financing options for businesses, there are some advantages in a personal loan. Here’s how personal loans compare to:

Investors

Depending on your business model, it might be easier to get a bank to grant you a loan than to find investors willing to give you money. You also get to maintain control over the company and keep all the profits yourself. That’s typically not an option with investors.

Business loans

The Consumer Financial Protection Bureau reported many startups aren’t able to get financing when applying for loans within their first few years of operations. If you have good credit and a reliable source of income, a personal loan for business could be easier to qualify for if your company doesn’t have an established credit history.

Crowdfunding

Crowdfunding through sites such as Kickstarter will allow you to fund your company through contributions from anonymous investors. However, it can be time-consuming and difficult to publicize your campaign to raise funds. Plus, there’s no guarantee you’ll raise enough money. Depending on the platform you use, you might also need to give up a small stake in your company to contributors.

Personal Loan for Business Caution

4. What’re the disadvantages of using a personal loan for business?

A personal loan for business isn’t the perfect solution. It can have some disadvantages, too, including:

  • Strict qualification requirements: If you don’t meet the criteria to get approved, you won’t have access to this funding source.
  • Your personal wealth could be jeopardized: If you can’t repay the loan, creditors could get a judgement against you. This could lead to wage garnishment, a lien on your house, or bankruptcy.
  • You’re taking on all the risk: If you were able to find investors, it wouldn’t just be your funds at stake. By using a personal loan for business, only your finances are at risk.
Ultimately, whether a personal loan is the best choice will depend upon how you balance risk versus reward.

 

The level of risk is greater when using a personal loan for business because you’re putting your credit on the line. Of course, if your company becomes successful, you reap all the benefits.

5. Can I afford to pay back the loan?

Finally, you’ll need to make sure you can afford to make payments on your personal loan for business. When you borrow, repayment will start right away. If it’ll be years before your company is profitable, can you afford to make payments in the meantime?

Making the choice to borrow is easier if you have savings to cover loan payments, an alternative source of income, and a clear idea for when your company will become profitable enough to cover loan costs.

Unfortunately, even the best business idea can fail, no matter how detailed your roadmap. Before you borrow, think through the consequences. Ultimately, you must decide if your business is worth putting your personal credit and financial stability on the line. If you aren’t willing to take the risk, you might have to look for other funding sources or grow your company more slowly.

The above content should not be construed as legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation.

Andrew Josuweit
Andrew Josuweit is the CEO of Student Loan Hero, a company that combines easy-to-use tools with financial education to help the millions of Americans living with student loan debt manage their student loans smarter. Student Loan Hero is helping 200,000+ borrowers manage and eliminate over $3.5 billion dollars in student loan debt.