Personal Business Loans: How to Choose and Apply for One

personal usiness loans, startup loans, small business loans

Looking to start a business? Personal business loans can be a key financing tool to help your startup get off the ground. But plan carefully. Your startup loan can make your business succeed — or fail.

Find the right loan and use your funds wisely. This planning process begins well before you fill out a loan application.

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Why use a personal loan to start a business?

First of all, why use a personal loan to start a business? Because without a business track record, lenders must base their decision on your personal credit history. They focus on your debt management skills and your future ability to repay the loan.

For personal business loans, the nature of your enterprise and your business qualifications may also come into play.

Using a personal loan to start a business can help you build a business credit history. The advantage of building a business credit track record is that in the future, you may be able to borrow for your business without a personal guaranty. And perhaps at lower interest rates.

Related: What Is a Personal Loan, Unsecured Loan or Signature Loan?

What to do before you start looking for personal business loans

Here’s where the preparation comes in. Before you even start shopping for a personal business loan, do some advance planning to improve your chances of being approved/ And to make sure you get a loan that meets your needs.

These are some early steps to take:

Review your credit

Because personal loan underwriters verify your credit history, you need to check your credit score and credit report to make sure there are no problems that could stand in your way. These issues can take time to correct, so check your credit very early in the process.

If your FICO credit score is 740 or higher, you should be in good shape. Between 670 and 739 may be okay, but there is room for improvement if you want to increase your chances of approval and get better loan terms. If your credit score is below 670, you’ll have fewer loans available and the terms won’t be as attractive.

Plan your company’s cash flow

Startup loans need to cover more than just the initial cost of opening your company’s doors on Day One. Assuming your new business won’t be profitable immediately, you need to obtain enough financing to operate long enough to build revenues that can cover your expenses. Figuring this out will tell you how big a loan you need.

Assess your current resources

Look at your assets to see if you can reduce the amount you need to borrow. Do you have unused assets that you can sell? Or use as collateral for a secured loan? Most personal loans are unsecured, but having collateral can improve your probability of approval and the loan terms you get.

Budget your payments

Once you know how much you want to borrow, determine if you can afford the payments. Check personal loan interest rates for people with your credit rating. Remember that if your credit isn’t great, you probably will not get the best rates available. Use a loan calculator to see what your payments would be for different loan lengths. Then see if  you could afford these payments on your budget.

Related: Pros and Cons (Personal Loan vs Credit Card)

Choosing between startup loans

Your preliminary research should help define what kind of startup loan you need, so now you can compare personal business loans to see who offers the best terms for the financing you want.

The goal of this comparison shopping is to narrow the field of possibilities before you start the paperwork. Applying for a loan will affect your credit score, and there might be an application fee involved. So you want to identify the most likely targets before you apply. You can do this by looking at the loan terms.

Length

Generally speaking, the longer the loan, the higher the interest rate. So make sure you are comparing apples to apples by looking at loans of the same length. Your cash flow and budgeting research should give you a idea of what loan length suits your needs.

Interest rate

If you have great credit, you can probably focus on the best rate each lender advertises. However, the lower your credit score is, the more you should focus on the high end of the advertised range when comparing lenders.

Underwriting

Knowing your credit score and financial situation, see if you can talk to representatives of the lender to find out if they are likely to lend to someone with your qualifications. Ask whether they have a prescreening or preapproval process so you can assess your chances without dinging your credit score.

Application and closing fees

These can be significant numbers, so include them when assessing the total cost of possible loans. Personal loan lenders must disclose the annual percentage rate, or APR, when advertising loan interest rates. The APR include both the interest charged and the upfront and other fees the lender charges.

APR helps you compare loans with different interest rate and fee combinations. But you must always compare loans with the same length or APR is meaningless. If the APR and interest rate are the same, this means the lender charges no fees.

Related: Personal Loan Interest Rates (How to Pay Less)

Applying for personal business loans

At this point you should have a shortlist of possible lenders and are ready to start applying for startup loans. Here’s how to go about it:

Make sure your credit report is lender-ready

Double-check your credit before you start applying to make sure it is what you think it is, especially if you’ve been working on clearing up any problems or otherwise improving your credit score.

Know your debt-to-income (DTI) ratio

Your DTI ratio is a key indicator of your ability to repay. This is the ratio of your recurring monthly expenses to your income. DTI does not include living expenses like utility bills and food. It does include debts like your rent or mortgage, credit card minimum payments, auto and student loans.

Lenders calculate your DTI including the payments on your proposed loan. A DTI of 36% or lower is highly desirable. With a DTI between 37% and 50%, your approval may rely heavily on other factors and you most likely won’t get the best loan terms. If your DTI is above 50%, you should probably work to bring it down before you apply for a loan.

Offer a concise business plan

A lender might be interested in your proposed use for the money, so have a summary of your business plan ready that lays out how your startup will be successful. You should also highlight any relevant business experience you have.

Act decisively

Loan applications affect your credit score, but similar applications within a few weeks will be considered as a single event rather than multiple attempts to obtain credit. So, be prepared to concentrate your application activity rather than allowing it to stretch out over a long time.

Once you have your startup loan, be sure to focus on making your payment on time and in full. Businesses often have ongoing needs for credit even once they are profitable, so keeping your credit in good shape can be of benefit to your enterprise beyond the startup phase.

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