Personal loan or business loan: which fits your situation

If you’re a sole proprietor or run a young business, you can often borrow two ways: a personal loan in your own name, or a business loan in the business’s name. Both can put cash in the account this week. They differ in who’s responsible for the debt, where it shows up on credit reports, how much you can borrow, and which laws protect you.

The short answer

A personal loan is usually simpler and faster to get when the business is new, the amount is small, and the lender allows business use. A business loan usually fits better once the business has a few months or years of revenue, when you need a larger amount, or when you want to build a credit history for the business itself.

Liability and personal guarantees

With a personal loan, you’re responsible for the debt whatever happens to the business. With a business loan, the business is the borrower, but that protection is thinner than it sounds: most lenders to small businesses ask the owner to sign a personal guarantee, which makes you responsible if the business can’t pay. Read the guarantee carefully. Some are limited to a dollar amount; many are unlimited.

Credit reports

A personal loan appears on your personal credit reports, and the balance counts toward your debts when you apply for a mortgage or car loan later. A business loan may be reported to business credit bureaus instead, which can help the business qualify for credit on its own over time. If you sign a personal guarantee, the lender may still check your personal credit.

Protections and disclosures

The federal Truth in Lending Act and Regulation Z cover consumer credit. They require lenders to disclose the APR, the finance charge and the total of payments in a standard format before you sign. Credit that’s mainly for a business purpose is exempt (12 CFR 1026.3). Some states have stepped in: California and New York require many providers of commercial financing to disclose costs, including an estimated APR, when they make an offer, and several other states require other cost disclosures. Wherever you are, ask for the total cost in writing; you may need to work out the APR yourself.

That matters most for short-term business products priced with a factor rate rather than an interest rate. Our factor rate to APR calculator converts one into an estimated APR so you can compare it with a regular loan.

If the business closes

This is where the difference between the two shows up most. A personal loan doesn’t change if the business stops trading: the payments stay the same and you keep making them. With a business loan, the lender will usually look first to the business’s assets, then to anyone who signed a personal guarantee. If you signed one, closing the business doesn’t end your obligation. Ask any lender how a closure would be handled before you sign.

Taxes

Interest on money used for a business purpose may be deductible as a business expense, while interest on personal borrowing generally isn’t. If you use a personal loan for the business, keep records that show where the money went. The rules have limits and exceptions, so check with a tax professional.

When a personal loan can make sense

• The business is new and has little or no revenue history.
• You need a modest amount and can repay it from your personal income if the business is slow.
• The lender’s agreement allows business use. Check before you apply; some prohibit it.
• You’re a sole proprietor and the business finances are already closely tied to your own.

When a business loan makes sense

• The business has steady revenue and bank statements to show it.
• You need more than a personal loan lender would offer based on your income.
• You’re buying equipment or property that can secure the loan.
• You want to keep business debt off your personal credit reports where possible and build the business’s own credit.

If the business is new and you’d rather not borrow personally, look at the SBA’s microloan program, which lends up to $50,000 through nonprofit intermediaries, many of which also offer training and support.

Questions to ask any lender

1. Can I use this loan for my business?
2. Do I have to sign a personal guarantee, and is it limited?
3. What’s the APR, or the estimated APR if you quote a factor rate?
4. What’s the total I’ll repay, including every fee?
5. How often are payments taken, and from which account?
6. Is there a fee or a lost discount if I pay early?