Personal Loans for Small Businesses: A Guide to Financing Options
You’ve scrimped and saved, put in the hard work, and made sacrifices to convert your side hustle into a legit business. Now it’s time to take your enterprise to the next level. But that can be costly. Instead of disrupting your cash flow or dipping into savings, consider the benefits of using personal loans for small business expenses.
As you research how to apply for a personal loan for a small business, be sure to look at the low-cost funding options on credit union personal loans available through your local credit union.
But first, let’s take a look at types of personal loans, eligibility requirements, and other factors to weigh when applying for a small-business personal loan.
Understanding Personal Loans for Small Businesses
When you take out a personal loan, you can use the money for any purpose, such as planning a wedding, financing home repairs, covering an emergency, and even funding a start-up. Personal loans, which can range in amount from several hundred dollars to several thousand, are called installment loans because you receive your money in a lump sum and pay it back over time in monthly installments.
The specifics vary by institution, but generally, to be eligible for a personal loan, most lenders require the following:
- a good credit score and history
- a steady minimum income
- a low debt-to-income ratio
Some organizations also require you to have an existing account or membership. For example, to be eligible for credit union personal loans, you must be a member of your local credit union.
Personal loans fall into two main categories: secured and unsecured:
- Secured loans are backed by collateral such as your home, vehicle, deposit certificates, or stock shares. In the case of default, the lender may seize the collateral.
- Unsecured loans don't require any collateral. Lenders approve unsecured loans based on a borrower's creditworthiness instead of relying on a borrower's assets as security. For this reason, unsecured loans tend to offer higher interest rates than secured loans.
How Personal Loans Can Be Used for Small Businesses
Although personal loans are often used for business expenses, they differ from small-business loans. Small-business loans are more likely to require that you put up collateral to secure your loan. They also come with eligibility requirements centered around the business's financial performance.
On the other hand, personal loans are most often unsecured loans obtained after the lender evaluates your personal financial history. Additionally, while business loans provide up to $5 million for as long as a 25-year term, personal loans tend to peak at $50,000 with terms no longer than 60 months.
One thing personal loans have in common with small-business loans: They can provide business owners with a quick infusion of cash to cover unforeseen expenses and to fund activities that will take their business to the next level.
You can use personal loan money to boost inventory, run a marketing campaign that drives sales, fund an expansion project, or hire staff. In other words, a personal loan can enable your business to grow without straining your cash flow or diminishing your resources.
Choosing the Right Personal Loan for Your Small Business
When you delve into the nuts and bolts of a personal loan, you will discover a variety of choices to suit your needs. Here are some of the most popular types of personal loans:
- A co-signed or joint loan may be a good choice if you cannot qualify for a personal loan and need a partner willing to assume responsibility alongside you.
- Fixed-rate loans offer an interest rate that doesn't change over the repayment term, making payments easier to budget.
- Variable-rate loans can fluctuate depending on marketplace volatility, but they usually come with an overall lower interest rate than fixed-rate loans.
- A personal line of credit gives you access to a pool of funds you can borrow from any time you need cash, and you only pay interest on the amount of money you draw.
Personal loan interest rates, fees, and terms
When you secure a loan, you will repay more than you borrowed, thanks to interest and fees. Interest is the amount of money a financial institution charges to allow you to use its funds, expressed as a percentage of your loan. Fees may come in the form of service fees or late payment penalties.
Fortunately for credit union members, interest rates and fees on credit union personal loans are usually lower than you’ll find at banks!
Be sure you understand the repayment terms of a personal loan offer before you sign on the dotted line. Your financial institution will provide a fixed period to repay your loan, usually 12 to 60 months. Extended repayment periods will lower your monthly loan payments, but you'll pay more interest. Conversely, short repayment periods typically result in lower interest rates but at a higher monthly expense.
Also, pay attention to other costs, like potential origination fees (a percentage of the loan amount), pre-payment, and late-payment penalties.
Applying for a Personal Loan for Small Business
When you apply for a loan to support your business, lenders will do a risk analysis, starting with your application. You will need to provide information about your personal finances, including your credit score, credit history, income, and debts.
The loan application requires your Social Security number, address, and income. In addition, you will need to provide other documents, including:
- proof of your identity, such as a driver’s license or passport
- proof of your income in the form of pay stubs, tax returns, W-2s or 1099s, and financial statements
- proof of your address, typically via a utility bill, your rental agreement, a mortgage statement, current voter registration card, or your property tax receipt
Many lenders, including credit union personal loans, offer online prequalifying. It usually involves filling out a short web form with your name, address, income, and amount of money you want to borrow. The lender will do a credit check and notify you quickly if you have prequalified for a loan. The next step is to complete the formal loan application.
Most lenders will advise you within a few days of applying if your application is approved. Then, it’s time to close the loan with a signed promissory note that indicates you accept the terms. The lender will transfer the money into your savings or checking account, give you a check to deposit, or complete a wire transfer into your designated account.
Risks and Precautions of Personal Loans for Small Businesses
When you take out a personal loan to boost your small business, you have put your personal assets and business at stake. Take precautions to ensure you understand the terms and conditions of your loan and only deal with reputable lenders.
If your credit score could be better, you may be vulnerable to predatory lenders who make high-interest loans easy to obtain. Easy borrowing can be a red flag and a signal you should take a close look at your contract so you won't be caught off guard should your interest rate spike.
Even though unsecured personal loans do not require you to post collateral, there are still consequences if you fail to pay the money back. Sometimes, missing a payment by even one day can be expensive. The consequences grow harsher as more time passes without making a payment. This harms your credit score and will make it harder for you to qualify for loans in the future.
Avoid scams and predatory lending
If you receive an email, text, or social media ad about an excellent opportunity to borrow money, beware! This messaging could be advertising a scam or a predatory lender, particularly if you've recently searched for terms related to how to apply for a personal loan for a small business.
Many loan scams provide terms so unforgiving that borrowers will be subject to bogus late fees or other charges. Watch out for lenders that tout upfront fees, offer loans without a credit check, or advertise private student loan forgiveness and debt consolidation. If it seems too good to be true, it likely is.
Alternatives to Personal Loans for Small Businesses
If you’re looking for a personal loan alternative or supplement, there are other ways to secure funding for your small business. Here are some popular options:
Business credit cards
A business credit card can keep personal and business expenses separate. Look for cards with competitive interest rates, benefits, and perks, such as cashback and introductory 0% interest rates. And check out the fees associated with the card to ensure it is not cost-prohibitive.
Business line of credit
A business line of credit is a type of flexible loan. Borrowers are approved up to a certain amount and can draw on their line of credit as needed, paying interest only on the amount actively borrowed. Business lines of credit are typically approved for several months or up to several years, depending on the lender.
A low-risk way for business owners to increase capital, crowdfunding raises money from a pool of people who aren’t technically investors because they don’t receive a share of ownership in the business and don’t expect a financial return on their money. Instead, donors often receive premiums or gifts as rewards from the recipients of crowdfunding campaigns.
The Small Business Administration's MicroLoan Program provides small loans to start-ups and newly established or growing small businesses. Under this program, the SBA makes funds available to not-for-profit community-based lenders, such as credit unions, that serve as microlender intermediaries for loans to eligible borrowers.
Peer-to-peer (P2P) lending enables business owners to obtain loans directly from other individuals, cutting out the financial institution as the middleman. P2P lending is also known as “social lending” or “crowd lending.”
Further Resources on Personal Loans for Small Businesses
Here are some helpful websites with more information on the benefits of using personal loans for small business expenses.
- Get off the ground. The Small Business Administration provides information about many programs to help small businesses grow.
- Know your rights. The Consumer Financial Protection Bureau is a government agency dedicated to ensuring individuals are treated fairly by banks, lenders, and other financial institutions.
- Ensure your success. The U.S. Department of Treasury offers a variety of programs to help small businesses succeed.
Build Your Business with Credit Union Personal Loans
Whether you’ve been a small business owner for a while or are just beginning your journey, credit union personal loans can help you get your business rolling, put it on firmer footing, or enable it to reach its full potential. Use our Credit Union Locator Tool to find a credit union near you where you can learn how to apply for a personal loan for your small business.