Is It A Good Idea to Take Out A Personal Loan to Set Up Your Business?
Setting up a business is not an easy task. It takes a lot of hard work and money—more than you expected. Fortunately, there are ways to get money for launching your business. The first one is small business loans, and the second one is personal loans.
While both of them seem to be quite similar, there are significant differences between them. Today, we will discuss the second business funding option, and that is a personal loan.
What are the benefits of taking out a personal loan for setting up your business?
You can get a personal loan easily.
Unlike business loans, it is easy to qualify for personal loans. You don’t need to show extensive business documents and plans to lenders. When you apply for small business loans, you have to show your income tax returns, pay stubs, and business plans to prospective lenders.
When you apply for personal loans, lenders will look at your credit history and income. The terms and conditions of personal loans are more favorable than business loans when you have a good credit score.
If you are lucky, you may qualify for a personal loan at a low-interest rate.
Also read: 4 Ways to Finance Your Tech Startup
Documents you need to show for a personal loan.
- Mail Address
- Email Address
- Social Security Number
- Date Of Birth
- Bank Statement
- Federal W-2 form
- Pay Stub
Documents you need to show for a business loan.
- Business’s cash flow statements
- Profit and loss statements
- Balance sheet
- Tax returns
- Business credit score
- Business bank account statement
You can get the fund quickly.
When you apply for a business loan, it may take a long time to get the fund. The entire process may take weeks or even months. But for personal loans, you may get the money within a few days.
There is no need to risk your assets.
With business loans, you have to pledge collateral. If you default on your business loans, lenders may seize your assets.
You may not face this issue with personal loans. Usually, these loans are unsecured. If you default on personal loans, lenders are less likely to come after you to seize your assets.
What should you do before you accept a personal loan?
- Check the repayment term and the annual percentage rate.
- Calculate how much you can borrow and how much you have to pay. (You can use a personal loan calculator for this.)
- Check the minimum credit score and income you need to have to qualify for a loan.
- Find out if you have to pledge any collateral.
- Ask how soon you can expect to get the loan.
- Inform the lender that you want to use the personal loan to set up your business.
- Read the loan agreement carefully to be sure that you are not violating the clauses of the loan agreement.
Why is it not a good idea to set up a business with a personal loan?
You may not qualify for a huge loan amount.
You can get as much as 5.5 million dollars in a business loan. But you can’t expect to get such a high amount in a personal loan. The maximum amount you can get is a hundred thousand dollars with a personal loan. The amount may not be enough if your business needs a massive investment.
You may end up paying more.
Usually, personal loans have low-interest rates. But, you can qualify for them only when you have a perfect credit score. Even when your salary is low, you may not be eligible for a personal loan. A personal loan with a high-interest rate may require you to pay more in the long run.
- You have qualified for a personal loan at a 5% interest rate.
- The loan amount is $25000.
- The repayment term is five years.
- In this situation, you have to pay around $28000 to the lender.
- The lender gives you $25000 at a 35% interest rate with a five-year repayment term. The amount will be around $53000, which is almost double what you borrowed.
- Here, you have to pay a massive amount to the lender.
- In the first scenario, the deal is affordable. However, in the second, you could lose a lot of money.
You may hurt your credit score.
What if your business does not do well and you cannot make payments on your personal loan?
Lenders will report missed payments on your credit report, and your FICO score will go down. A series of late payments and a low credit score may make you ineligible for other types of loans.
What if you make payments on time? Well, you might be able to save your credit score, but your debt to income ratio will go up. That may cause trouble when you apply for a mortgage.
Which one should you choose? A personal loan or a business loan?
Well, everything depends on your financial situation and your business needs. Plus, you have to check how much lenders are charging on interest rates.
Are you willing to risk your credit score? This is yet another factor that you need to consider.
Flexibility is a significant benefit of a personal loan. Unlike other loans, you can use a personal loan for any purpose. You can use it to consolidate credit cards, set up a business, cover your wedding expenses, and more.
It’s best to have a clear discussion with the lender about how you want to use the personal loan to avoid any financial problems in the future.