Business loans vs personal loans

By   |   Verified by David Boyd   |   Published 31st August 2021

  • Do you need financing for your business and wonder whether you should opt for a personal or business loan?
  • Business loans may be specific for the business, but they could require lots of paperwork and will likely still depend on your credit history.
  • A personal loan may be easier to get, but your assets might be at risk in case of default.

Investing in your business is easy if you have access to capital. But when you have to borrow money, deciding between a business and a personal loan could be challenging.

Although you may think a business loan is the most appropriate choice, a personal loan could have more flexible terms. There are pros and cons to both methods, so it’s important to know what your options are before making your decision.

Business loans

Business loans are specifically designed to provide business owners with funds that can be used exclusively for business purposes.

You can use a business loan to pay for things like hiring new staff, paying rent for your business premises, or buying inventory. However, you can’t use a business loan to consolidate personal debts, even if you’ve invested those funds in your business.

Some of the most common ways to use a business loan include:

  • Replenishing stock or buying stock in bulk
  • Paying your staff
  • Settling business bills and invoices
  • Funding a marketing campaign
  • Investing in new equipment or new technology
  • Moving to new premises
  • Staff training
  • Consolidating existing business debt

Types

  • Term loans. A business term loan can be secured or unsecured. Term loans provide a lump sum of money that you’ll have to pay back over a predetermined period of time. They include caveat loans, requiring you to use land or property as security against the borrowed money.
  • Line of credit. Like an overdraft, a business line of credit gives you instant access to money up to a limit agreed with your bank. Most lines of credit have no term, and you’ll only pay interest for the money you use.
  • Merchant cash advance. This type of loan allows you to borrow against your future earnings. The lender will then charge your account or credit card to get the money back. This type of loan gets approved quickly, but interest rates are high.
  • Equipment financing. Similar to term loans, but you can only use the funds to buy new equipment.
  • Commercial mortgage. Ideal if you want to buy a commercial property, including an office, a warehouse, or other commercial premises.
  • Chattel mortgage. If you want to buy movable property instead of commercial premises, a chattel mortgage is a great alternative to a commercial mortgage.
  • Invoice financing. If you struggle to collect payments on time, invoice financing allows you to use unpaid invoices as collateral to get an advance of the money you’re owed. You will still have to pursue payment to pay back the amount. Similar to invoice financing, invoice factoring allows you to sell your unpaid invoices and get a percentage of the amount you’re owed.

Common features

  • Flexibility. Although most lenders will ask for a business plan to assess the risks before lending you money, most business loans give you the option of using the funds for any business-related purpose.
  • Favourable interest rates. Most business loans have more attractive interest rates when compared with personal loans.

Typical costs

Business loan interest rates vary from approximately 5% to as much as 30% p.a. and vary based on the lender, your risk profile, the product selected, repayment term, etc.

Fees, which also vary between lenders, may be charged for processing an application, early repayment, etc.

Liability

Who is liable for the loan depends on the type of business you have. If you’re a sole trader, you will be liable personally. If your business is incorporated, your company will be liable, protecting you from personal liability.

Who can get them

Lenders typically require a business to have an established trading history. Therefore, a business loan is not suited to startups. Sole traders may also struggle to meet eligibility criteria.

Pros and cons

Pros

  • Build your company’s credit history by repaying on time, which may help you get favourable terms in future.
  • Business loans generally allow you to borrow more than is possible with a personal loan.
  • Longer repayment terms are possible.

Cons

  • Your assets might still be at risk, depending on the type of company you have.
  • More paperwork is involved, for example, you may have to produce a business plan.
  • You may not be eligible if you don’t have sufficient trading history.

Personal loans

Personal loans are designed to provide individuals with funds that can be used for various purposes, such as buying a car, appliances and technology, going on holiday, paying an unexpected bill, etc.

As long as the loan agreement doesn’t specifically state that you can’t use the money to fund your business, you could also use the personal loan to invest in your business.

Types

  • Term loans. These may be secured or unsecured with a fixed or variable interest rate. Some can be used for generic purposes, meaning that you can use the funds for anything, whereas others — such as a car loan — can only be used for the intended purpose.
  • Overdrafts. This is an extension of credit linked to your bank account, allowing you to use more money than you have up to an agreed limit. You will only pay interest on the money you use.

Common features

  • Redraw facilities. Variable interest rate loans generally allow you to redraw from overpayments.
  • Personalised rates. You will get a lower interest rate if you have a good credit history.
  • Early repayments. Many personal loans have no early repayment fees, meaning that you can reduce costs by paying the loan in full before the term.

Typical costs

Most personal loan rates vary from approximately 5% to 15% p.a. Other costs include application and administrative fees. The comparison rate displayed includes these.

Liability

You will be liable for missed payments and could lose any assets used as collateral if you don’t keep up with the payments.

A personal loan will be reported in your personal credit score, which will be affected — for good or bad — by your repayment history.

Pros and cons

Pros

  • Minimal documentation required, especially if applying for an unsecured loan.
  • Fast approval times, with some lenders transferring funds on the same day or even within an hour, depending on who you bank with.
  • Flexible repayment terms, which typically range from 1 - 7 years in duration.

Cons

  • Interest rates are personalised based on your personal credit rating, which can work to your advantage or disadvantage.
  • Possible restrictions. Some lenders do not permit personal loan funds to be used for business purposes.

Alternative funding options

  • Credit cards. A personal credit card gives you instant access to funds, and you will only pay interest on the money you use. Their interest rates are generally around 20% p.a. and you can earn rewards points.
  • Business credit cards. Again, interest rates are around 20% p.a., with useful features like the ability to add cards for employees. Typically come with a substantial bonus for signing up (with spending target).
  • Charge cards. These function like a credit card, but the balance must be paid in full each month. Generally only on offer from American Express in Australia.

Which is better?

A personal loan could be a great choice for a new business, since it is unlikely you will be eligible for a business loan due to insufficient trading history. However, you should make sure that you are allowed to use the money for business purposes before applying.

If your business has an established trading history and is in relatively good operating condition, you have various available financing options that could remove your personal liability for the loan repayment and allow you to borrow more.