India is considered to be one of the top breeding grounds for start-ups. Today, it ranks number three in the world in the start-up business category. With immense entrepreneurial capability and passion for business, Indians are entering the start-up genre like never before. As capital becomes more affordable and is critical for start-up businesses to grow, the market today is flooded with several personal loans as well as business loan options.
The launch of government-backed schemes such as MUDRA loans is proof of the kind of support businesses tend to enjoy from the government. It has managed to disburse nearly Rs. 6 lakh crores to about 12 crore individuals from the time of its launch. Young entrepreneurs often get confused while choosing between a business loan and a personal loan. While there’s no simple answer, we help you choose the right loan product by listing the features and benefits of both.
Personal loans can be easily approved as long as one has good credit and can show a steady flow of income. Businesses applying for a personal loan must have an adequate debt-to-income ratio. If the absence of good credit, one can go for secured loans which require collateral commitment.
When it comes to business loans, excellent credit is a foremost criterion to qualify for the same. Lenders could sometimes ask for personal as well as business credit scores. Businesses may also need to show sufficient annual revenue and the number of years in the industry. Some online lenders may provide expensive business loans to entrepreneurs who cannot easily match up to the criteria.
Personal loans are designed by financial institutions to help meet an individual’s personal needs like wedding, home refurbishment, or other emergency cash needs. The interest rates associated with personal loans are generally high. Personal loans may not be ideal for entrepreneurs since they could end up incurring the higher cost of funds especially if their business is in the nascent stage. This is when business loans can prove to be helpful for them.
A personal loan comes with shorter tenure as far as repayment is concerned. Business loans, on the other hand, tend to have longer tenure. Thus, entrepreneurs may have to pay more money in the form of EMIs per month when opting for a personal loan. This could impact the cash flow of the business and damage its growth in the early stage.
Future Lending Conditions
Funding a business with the help of a personal loan could mean higher interest rates and also the associated EMI payments. In such cases, there is a higher probability of default which could bring in cash flow troubles in the future. This is why most business owners find it challenging to establish credibility and fetch better lending terms in personal loans. This indicates that business owners are better off with business loans.
Usage of Funds
If business owners borrow a personal loan, they may end up using it for a personal emergency. This could indicate a lack of discipline and misuse of existing funds especially when they are being used for situations that are not associated with driving business growth. A business loan can make sure that entrepreneurs do not have to deal with such problems.
Making Use of Government Schemes for Business Growth
For businesses which qualify for the government’s credit guarantee schemes, they can easily get collateral-free funds of maximum Rs. 1 Crore. Thus, a business loan with a better interest rate can suit the needs of business better as compared to a personal loan. A personal loan of Rs. 1 Crore could prove to be risky for a business which is just starting up.
While personal loans are available instantly, as long as the basic eligibility criteria are met, these are best suited to address an emergency financial need. It is best to avoid taking a personal loan for business expansion. Smart entrepreneurs would rather go for a business loan instead of falling into the personal loan trap.
Purpose of Loan
The purpose of a loan and its urgency can influence decision-making while choosing a business loan or personal loan. If the loan requirement is too high but the business is performing well, there are better chances of getting a business loan at reasonable interest. However, if it is an emergency financial need, a personal loan can be easily available as compared to a business loan. Depending on the need and the quantum of need, entrepreneurs can make the choice between the two available loan categories.
Additional Reading: Personal Credit Score vs Business Credit Score
In a Nutshell
|Secure large loan amounts
Longer repayment tenures
Repaying the loan on time helps your business build good credit history and improve business credit scores
|Difficult to obtain - especially for new businesses and entrepreneurs who are just getting started.|
|Easier to obtain
|Higher interest rates
Doesn’t help to build your business credit score
The Bottom Line
Business requires loans for different purposes such as managing working capital needs, expansion and infrastructure expenditure, investment in systems and equipment, etc. These requirements could mean large amounts of money and the business must ensure that the cost of capital is affordable and practical. Therefore, business loans are considered to be equipped for funding business growth as against personal loans.
When an entrepreneur is starting a business and cannot use his or her savings, or raise funds easily, business loans ensure sustainable growth of the business. Entrepreneurs who wish to nurture and create a successful business empire and a sustainable brand must apply for a business loan rather than go for the easier choice of personal loan.