Things to Consider Before Funding Your Business With a Personal Loan

Man thinking of funding your business with a personal loan

You’ve got an excellent business idea, you know there’s demand based on your market research, and you have a plan to bring that idea to this market.

However, you don’t have the funds on hand to make your dream a reality. You feel you need a loan for your business, yet business loans often have strict requirements — they’re generally only suitable for companies with a track record.

A personal loan could be your answer. Even though you’ll be responsible for more debt, using a personal loan to invest in your business could pay off significantly down the line.

There are some things to keep in mind when considering a personal loan to fund your business, though. But before we get to those, let’s quickly define what a personal loan is.

What is a Personal Loan?

Personal loans are loans you can take out for a variety of purposes, including starting a business.

Speaking of getting loans for businesses, personal loans are often easier to get than business loans, making them excellent tools for brand new entrepreneurs without enough capital on hand.

However, they may not be for everyone. In fact, a survey found that barely 1% of personal loan borrowers even use their loan to start a business. This signals that personal loans may not be the best financial tool for every entrepreneur out there.

With that in mind, make sure you consider the following before getting a personal loan for your business.

Things to Consider Before Getting a Personal Loan For Your Business

1. The Fine Print

A fair number of personal lenders are fine with you using your personal loan on anything, as long as it’s legal, of course.

However, some personal lenders may be a bit picky. You might be restricted from using it for reasons they deem risky, such as starting a business. After all, if your business fails, they might not get their money back.

So check with each lender you’re looking at borrowing from to make sure you’re allowed to use your loan for business purposes before signing the contract.

2. What You Need the Money For

This might be obvious, but you should know exactly what you need the money for. That way, you can figure out exactly how much you need to take out. You don’t want to saddle yourself with extra debt.

Sure, if you overestimate, you might have some extra capital for other things. But without a defined purpose for every dollar, it’s easy to take out more than you need and end up throwing away money on interest. You’ll pay a higher interest rate on a higher principal balance, which can add up fast.

Not to mention burdening yourself with a higher monthly payment in general.

This plays into the next consideration you should make, your debt-to-income ratio.

3. Debt-to-Income Ratio

Your debt-to-income ratio (DTI) is a comparison of your monthly debt payments relative to your gross monthly income (income before taxes).

For example, if you have a $1,000 mortgage and $400 car payment, and you make $4,000 every month, your DTI ratio is 0.35, or 35%.

Most personal lenders won’t look at your DTI. However, it’s important to know your DTI for personal purposes.

If your DTI is already high (about 40% and above), adding another loan payment can stretch your budget thin. Even if your business is highly profitable early on, debt could eat up much of your earnings — preventing you from enjoying the spoils of your success.

So pay down some debts first if your DTI is already high. See if you can target some smaller “bad” debts,