Differences Between Personal and Business Loans:
By the time most entrepreneurs and small business owners start thinking about financing their projects, they have more than likely already been through the process of applying for a personal loan. Business loans, also known as commercial loans, are not like mortgages or credit cards; they have some similarities with personal lending products, but there are many important differences to consider.
Reasons to Get a Business Loan vs. a Personal Loan
- In the wake of the Great American Recession and the global financial crisis of 2008, the lending market for both personal and business loans has improved considerably. It is now easier than ever to apply for a personal or commercial loan, and lending advisors can recommend which loan works out better.
- Personal loans can be used for home improvements or to take care of unexpected life events, but such reasons do not usually have to be explained on the application. Business loans, on the other hand, require different risk assessments that explain the need for financing; this means that company owners can expect to provide more documentation.
- Although business loans are usually associated with startup companies in need of financing, they can also be beneficial for established businesses that are seeking to expand, add more staff, open a new branch, or obtain more equipment.
- It is not completely uncommon to see a business owner take a personal loan for commercial purposes; this is a situation often associated with startup companies that are not able to attract investors due to their unusual business plans. What is not recommended is taking out a business loan for personal purposes.
- In the end, prospective borrowers of personal or business loans should rejoice in the fact that current lending conditions are very favorable. Today’s application process has been streamlined for maximum efficiency, and the interest rates are still near historical lows. As the national economy continues to improve, the best time to apply for personal or business loans is certainly now.
Collateral and Ability to Repay
Banks and online loan companies make lending decisions based on two major factors: the borrower's ability to repay and the possibility of obtaining a collateral pledge.
Personal loan underwriting is mostly based on the ability to repay; for example, an applicant's credit profile and his or her job history are the main factors when issuing a credit card or an unsecured personal loan. Approval of car loans and mortgages requires collateral pledges.
Long-term business loans likely require company assets to be put up as collateral; this may include real estate and equipment. In some cases, the future earnings of the business, known as receivables, may be used as part of a loan repayment guarantee.
Depending on the type of lending product, commercial loan underwriters may look into the credit worthiness of the business owner as well as the financial statements of the company as well as the assets. A seasoned business may not require a review of the personal credit history of the company owner; a startup entrepreneur, however, will probably be expected to submit documentation that shows his access to reserves, past lending history, etc.
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