Business Loan vs Personal Loan – Which is Best for Growth?

Small Business – Business Loan vs Personal Loan in India?

India has the third largest number of start-ups in the world. We have great entrepreneurial energy and passion. Access to affordable capital is critical for small businesses to thrive and grow to generate enough operating income to sustain by themselves.

The government has been playing a role with the launch of schemes such as Mudra loans wherein it has disbursed Rs 6 lakh crore to 12 crore people since its launch in April 2015.

However, there is still a lot of dilemma among young entrepreneurs who are often confused about opting for a business loan over personal loan. While we cannot have a correct answer to this, a good evaluation with the context and life stage of the business could enable young entrepreneurs to take an informed decision on business vs personal loan for business. First, let’s quickly understand the meaning of both.

What is a Business Loan?

A business loan definition can be stated as a financing option designed specifically to meet the capital needs of a business, whether for expansion, operations, or asset acquisition. It allows businesses to access funds for diverse purposes, such as purchasing equipment, managing cash flow, or investing in new opportunities while paying back over a defined period with interest. 

Business loans often require financial records and a solid business plan to demonstrate the venture’s stability and potential growth. It ensures lenders of their repayment capacity. With flexible options like business loans, credit lines, and equipment financing, business loans cater to various business sizes and needs. It enables growth and stability across industries. 

What is a Personal Loan?

A personal loan meaning can be defined as an unsecured form of credit that individuals can use for a variety of personal financial needs, such as covering medical expenses, funding home improvements, or consolidating debt. Offered based on the applicant’s creditworthiness, income, and repayment history, personal loans come with a fixed interest rate and a set of repayment periods. 

Personal loans provide a manageable way to access funds with collateral. Because they offer flexibility in usage and do not require asset security, personal loans are widely sought after by borrowers who need immediate funds for personal or unexpected expenses while maintaining predictability in monthly repayments. 

Let’s delve a bit more into this and analyze is a business loan better than a personal loan:

Interest Rates:

Personal loans are a product that is created by financial institutions to cater to one’s personal needs such as a wedding, home improvement, or some urgent cash requirement. The interest rates are normally high. Entrepreneurs who opt for personal loans as against applying for a business loans will incur an increase in cost of funds which does not help a newly incorporated business.

Shorter Tenure:

A personal loan normally has a shorter repayment tenure compared to a business loan. This means that entrepreneurs will have to pay out more money in terms of EMI per month. This impact on the cash flow is not a favourable one for businesses that have been actively operational for a very little time.

Terms of Future Lending:

If an entrepreneur is funding his business through personal loans, the interest is high and so are the EMI pay-outs. The probability of a default and cash flow problems are much higher. In such a case, it becomes extremely difficult for the business owner to establish credibility and get attractive lending terms for future loans. Should new entrepreneurs apply for a business loan to ensure credibility for their businesses if nothing more?

Use of Funds for personal expenses:

As it is a personal loan, business owners may use it for an emergency personal need. This leads to a lack of discipline and mis-apportionment of existing funds towards initiatives that will not help to drive business growth. A business loan can enable entrepreneurs to circumvent such problems.

Leveraging benefits of Government Schemes for Business:

If the business qualifies for the credit guarantee scheme of the government, the business owner can get collateral-free loans of up to Rs. 1 Crore. In such a case, a business loan of such a high quantum at a better interest rate augurs well for the business compared to a personal loan. Meanwhile, a personal loan of Rs. 1 Crore without collateral backing would be a tall ask for anyone who is just starting his business.

While you can get a personal loan instantly if you fulfill the basic eligibility criteria or by just walking into your nearest ATM, it may, at best, address an emergency business need. It is not advisable as a practice to take a personal loan to expand your business. Astute entrepreneurs would apply for a business loan instead!

Amount and urgency of the loan requirement:

Both are critical factors which can influence the decision of opting for business loan vs personal loan in india. If the amount of the loan required is too high but the business has been doing well over the last few years, the chances of obtaining a business loan at favourable rates of interest is higher. As for the urgency of the requirement, a personal loan may be sanctioned faster than a business loan.

However, the personal loan amount sanctioned will be lesser in case the business owner has an existing personal loan, home loan, vehicle loan etc.

What’s better?

Is your business in the incubation phase? Has it started generating revenues? Has it started generating recurring cash flows? All these questions are significant to address the quantum of new business loan that can get sanctioned.

Business may require loans to manage working capital, expand presence and infrastructure, import systems and equipment, and so on. The amount required for such loans is substantial and it is in the interest of the business to ensure that the cost of raising capital is feasible and affordable. Hence, business loans are better equipped to fund the growth of an enterprise as compared to personal loans.

Unless an entrepreneur is just starting out and is in no position to use personal savings, or raise seed capital, business loans will give entrepreneurs a better chance to ensure sustainable growth of their enterprise.

If you are an entrepreneur who nurtures the ambition of creating a great business and an everlasting brand, it might be prudent to apply for a business loan instead of opting for a personal loan for business growth.

Also Read: Gold Loan vs Business Loan – Which is Better Option & Why?

Eligibility:

Business loans and personal loans have distinct eligibility criteria. Business loans consider the creditworthiness and financial stability of the business, requiring a solid business plan, revenue projections, and a business credit history. In contrast, personal loans are based on an individual’s credit history and financial situation. Small business owners should be prepared to provide proof of business income and a detailed business plan to secure a business loan. For personal loans, a strong personal credit score and financial history are more critical.

Collateral:

Business loans often require collateral, which can be business assets or personal assets, depending on the type of loan. Personal loans typically do not require collateral, as they are unsecured loans. The presence of collateral can affect the risk to the borrower. Business owners who can’t risk losing personal or business assets may prefer unsecured personal loans.

Repayment Terms:

Business loans typically offer longer repayment terms, which can range from a few years to several decades, depending on the loan type and amount. Personal loans have shorter repayment terms, usually up to seven years. The choice between the two depends on the business’s ability to make regular, larger payments (business loan) or the borrower’s preference for quicker repayment (personal loan).

Approval:

Approval for business loans often takes longer due to the need for extensive documentation and credit checks. Personal loans are generally faster to approve, making them more suitable for immediate personal financial needs. Small business owners seeking quicker access to funds for business expenses may find personal loans a more attractive option. However, business loans provide the advantage of larger loan amounts for significant business investments.

Apart from personal and business loans, you can also take gold loans. Let’s quickly understand the difference between gold and business loans. 

Difference Between Gold Loan and Business Loan

A gold loan is a type of secured loan where individuals pledge their gold assets as collateral to obtain funds quickly and with minimal documentation. Due to the security provided by the gold, lenders usually do not require a credit check. This makes gold loans accessible even to those with low or no credit scores. This type of loan typically offers lower interest rates than unsecured loans and allows borrowers to take out funds based on the value of their pledged gold. It offers flexibility in loan amounts suited to various personal or short-term financial needs. 

In contrast, a business loan is primarily designed to find business-related activities. It usually requires extensive documentation and a credit check if the loan is from a traditional bank. Non-banking financial institutions usually do not levy stringent measures. Business loans can provide higher loan amounts suited for substantial business investments. Although they are unsecured, resulting in higher interest rates, they are usually flexible for small, immediate funding needs. It involves a more comprehensive application and approval process as it reflects the focus on the borrower’s business stability and creditworthiness. 

Conclusion 

In deciding between a business loan and a personal loan, it is essential to assess each option’s unique benefits and requirements. Business loans are generally ideal for scaling operations while personal loans are more suited for smaller, immediate needs. Compare business loans to get insights into funding avenues designed specifically for business stability and growth. Ultimately, the choice depends on your business goals and financial capacity. Lendingkart simplifies this process by offering customised business loan options to fuel growth with ease and flexibility. 

FAQs:

1. Are the eligibility requirements for a personal loan different from those of a business loan for small businesses?

Yes, eligibility requirements for small business loan vs personal loan differ. Personal loans are typically based on an individual’s credit history and financial situation. In contrast, business loans consider the creditworthiness and financial stability of the business, often requiring business plans, revenue projections, and business credit history.

2. How does the interest rate on a business loan compare to that of a personal loan?

Interest rates on business loan vs personal loan interest rate tend to vary but can be either higher or lower than personal loan interest rates. The interest rate depends on factors like the type of loan, creditworthiness, and the lender. Generally, business loans might have a higher interest rate due to the higher risk associated with businesses.

3. In what situations should a small business owner consider choosing a personal loan over a business loan?

Small business owners may consider personal loans when their business lacks a substantial credit history or when they need funds for personal expenses. It can also be a viable option for sole proprietors or startups who don’t qualify for business loans.

4. How does the loan amount available differ between business loans and personal loans?

Business loans usually offer higher loan amounts compared to personal loans. Business loans are designed to finance various business needs, while personal loans are typically smaller and meant for personal expenses.

5. Are there any tax benefits associated with business loans that may not be applicable to personal loans?

Yes, there are potential tax benefits for business loans, such as deducting the interest paid on business loans from the business’s taxable income. These deductions can reduce the overall tax liability for the business. Personal loans do not typically offer these tax advantages unless the funds are used for a specific business expense and are properly documented. However, tax laws can vary, so it’s essential to consult with a tax professional.