When it comes to business loans vs. personal loans, many borrowers take the same approach. A loan is a loan, right? Business loans and personal loans are actually quite different and should be approached with different criteria, but it makes sense that most people think of them as the same. After all, most people have much more experience with personal loans than they do with business loans. Home mortgages are much more likely to be the subject of Thanksgiving dinner conversation than an SBA loan, for example. While understanding personal loans can help you decipher the financial jargon that often accompanies a business loan, approaching business financing the same way you’d approach a personal loan often limits your flexibility and return on investment. Personal Loan Overview Offered by a bank, credit union, or online lender, a personal loan lets you borrow a specific amount of money upfront. Then, you repay it with interest, usually through fixed monthly payments over an agreed-upon term, which may range from a few years to several years or longer. A personal loan is usually flexible, so you can use it to cover just about any personal expense. It can come in handy if you’d like to consolidate debt, fund a home improvement project, or pay an emergency expense, such as a car repair or medical bill. Most personal loans are unsecured so you don’t have to back them to collateral, like your house or car. Pros and cons of a personal loan ProsConsAllows you to fund a large purchase: With a personal loan, you can cover any expense, even if you don’t have the cash to pay for it up front.Interest rates may be high: Unless you have good or excellent credit, you might have to settle for high interest rates that increase your overall cost of borrowing.Flexible: A personal loan can be used to pay for a variety of personal expenses, like car repairs, medical bills, and home improvement projects. Potential fees: Some personal loans come with fees in addition to interest, such as origination fees, late fees, and insufficient funds fees.Can help you build credit: As long as you make your payments on time, every time, a personal loan may boost your credit score.May hurt your credit: Even one late or missed loan payment can take a toll on your credit score.Fast access to cash: In most cases, you can apply for a personal loan and receive the funds quickly, that same day, within 24 hours, or in a few business days.Can lead to unnecessary debt: A personal loan may steer you into a cycle of debt, especially if you borrow too much.Collateral isn’t usually required: While secured personal loans exist, unsecured personal loans are more common and don’t require you to put an asset on the line. Scams do exist: Some so-called personal loan lenders are scammers and may cause serious issues like identity theft. Using a Personal Loan For Business You may be surprised to learn that you can use a personal loan to fund a new or existing business. But before you go this route, check with the lender to make sure they don’t have any restrictions for business use. Using a personal loan for a business may be worth considering if you’ve exhausted other financing options, such as business loans, crowdfunding, and credit cards. This is particularly true if you have solid credit and are able to lock in a low interest rate and flexible repayment terms. Business Loan Overview A business loan is a type of financing designed for business owners. Some business loans offer a lump sum of money up front, while others are revolving lines of credit that give you the flexibility to withdraw funds as you need to. You may use a business loan to cover a variety of business-related expenses. It can help you launch your business and cover inventory and equipment costs. Or if you’ve been around for a while, a business loan might be just what you need to grow your business and fund larger purchases, like commercial real estate. Pros and cons of a business loan ProsConsMany options available: You can find a variety of business loans through banks, credit unions, and online lenders.Can be difficult to qualify for: If you’re a startup or a newer business, you might find it tough to get approved for a business loan as many lenders impose strict eligibility criteria. Flexible: A business loan may help you cover virtually any business-related expense, including commercial real estate, equipment, payroll, and marketing. Interest and fees: Due to their interest charges and fees, business loans can get expensive, especially if you don’t have the best credit.Lengthy repayment terms: Most business loans come with terms that range from a few years to several years or even longer, so you can take your time paying them back.Slow process: Some business loans require extensive documentation and a long application that can prolong the amount of time it takes to receive your funds. Can build credit: If you’re a new business, a business loan is a great way to build your credit and open the doors to attractive financing options in the future.Can hurt credit: While a business loan may improve your credit, it can also hinder it if you miss payments or default.Eliminate cash flow issues: With a business loan, you can meet your business goals without using up all of the cash you have on hand.May require collateral: Depending on the lender and loan type, you might have to back a business loan to collateral or a valuable business asset, like your commercial property or company vehicle. Business Vs. Personal Loan We’ll run through some of the shared components between business and personal loans to examine the different approaches borrowers should take to each loan type. Requirements One of the key differentiators is that you qualify for a personal loan based on your own credit score and personal income, while the qualification for a business loan depends on a broader range of criteria related to your small business. These can include things like business history, business income, business credit, your specific industry, and bank account activity. The Return on Investment Business loans tend to have much larger returns compared to the return on a personal loan. Personal Loans: The Loan Principal When you take out a personal loan, you expect to repay the loan principal. You might take out a loan to finance a home purchase or remodel. You might take out a loan to consolidate debt. You might use a personal loan for medical bills. In all of these cases, the loan helps you to pay for something with a fixed cost by breaking it into affordable payments over a longer period. If there is an opportunity to make a profit—as is the case with a home purchase or remodel—it tends to be a longer-term play, and profits tend to be a smaller percentage of the capital spent. Business Loan: Increased Sales and Profits The uses for business loans vary much more wildly and, therefore, so do the returns. Generally speaking, the return on investment for a business loan is determined by sales and profits. Sometimes that means that a loan is used as a safety net until your company receives payments it’s owed, as is the case with accounts receivable financing. Loan Terms With business loans, borrowers can often benefit from a shorter loan term versus the best-practice of looking for the longest term for personal loans. Personal Loans: Look For Longer Terms As a general rule, the best loan term for a personal loan is the longest one you can find. It gives you the most time to repay and reduces monthly payment costs. Business Loans: Shorter Loan Terms Are Often an Asset Because a business generates returns on a loan based on investment and profit, a small business can usually repay a loan much quicker than an individual. Say you need financing to make a large inventory order. Once you have that inventory, you can sell the product and turn it into profit. That process can be as quick as a few months. But if your loan term is two years, it may prevent you from taking advantage of other opportunities over the life of the loan. Most lenders will require that your loan is repaid before you can take out another loan. They make this requirement to prevent borrowers from taking out additional loans without any intention of repaying the original loan. This limitation can mean that if you come across another great opportunity that requires financing six months into your two-year loan term, you may not be able to take it. Shorter loan terms often give business owners more flexibility and agility. When you’re comparing loans, consider how quickly you think you’ll be able to repay. Opting for a shorter loan term may actually put your business in a better position down the line. How to Determine What You Can Afford What you can afford in a personal loan is determined by your income versus in a business loan, where the loan funds may change what you’re able to afford. Personal Loans: Cost of Capital Limited by Fixed Income Most personal expenses are fixed: the cost of your home, utilities, groceries, gas, etc. These all fall into your monthly budget, with some wiggle room for entertainment and discretionary spending. Personal income tends to be fixed, too. People generally receive the same salary payments month over month—with some wiggle room for commissions or months with more hours. You know the baseline that you can repay each month, and your ability to handle the cost of capital is calculated from there. Business Loans: Higher Profit Margins Can Make a Higher Cost of Capital Worth It Businesses operate on profit, not income. As such, a business can often handle a higher cost of capital than an individual can. To determine what cost of capital the business can handle, ask yourself what the loan will allow your business to do. If a loan allows you to cover employee-related expenses, you’ll want to ask yourself, what can your company generate with that labor? Purchasing a specialized canning machine may allow you to secure a new account. What profit would your company stand to gain if you had more working capital? By asking that, you can also see what you stand to lose if you don’t have the capital to pay for it. A loan with a 20% interest rate may actually serve you better than waiting for a 7% loan if that prevents you from taking advantage of current opportunities. How to Evaluate a Business Loan Don’t use the principles of personal loans and personal finance to weigh the pros and cons of a business loan offer. When looking for a business loan, you may choose a loan with a higher rate or shorter term than you would with a personal loan. Instead, ask yourself the following questions: What is the potential ROI on the loan? How quickly do you think your business will be able to repay it? If you go without financing, will it prevent you from taking advantage of X opportunity?