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While you might raise money through savings or investors, taking out a loan is a more common way to get a business off the ground. Here, we explore which type of loan might work best for you.

What is the difference between a business loan and a personal loan?

When funding a startup, borrowers usually choose between two types of loans: business loans and personal loans. Each works differently.

To clarify the differences, we’ll examine what each loan is, how it works and the pros and cons of getting a loan to start a business.

What is a business loan?

A business loan provides funding to companies, not individuals. Borrowers must explain why they need the money, with common reasons being to cover rent, hire and train staff, or purchase equipment or office furniture.Ìý

Business loans can be either secured or unsecured. With a secured loan, the lender can seize specific business assets—such as equipment, vehicles, or property—if repayments aren’t made. You may also be able to use personal assets as collateral.

Pros and cons of a business loan

Advantages include:

• Term length: Loan repayment terms of from one month to 25 years are widely available

• High-value loans: Borrowers can typically apply for amounts from £1,000 to several million pounds

• Credit report: Taking out a business loan and making all repayments can improve your business credit report

• Flexible loans: A range of loan types are available, including secured and unsecured business loans, property finance loans (such as bridging loans and buy-to-let mortgages), and working capital finance for short-term projects

Disadvantages include:

• Application process: Strict eligibility criteria mean you may wait weeks for approval

• Business risk: The lender may seize your assets if you miss repayments, making it hard to keep tradingÌý

• New business barrier: Many lenders require a solid business credit history, which can be a challenge for startups

• Personal guarantee: Without a business credit history, the owner may need to sign a personal guarantee, agreeing to cover payments if the business can’t. Not adhering to thisÌýlegally binding agreement could damage your personal credit score

What is a personal loan?

With a personal or unsecured loan, the individual, rather than the business, takes full responsibility for the repayments. The borrower agrees to repay the loan in monthly instalments, typically over one to seven years.Ìý

As the name suggests, these loans are generally for personal use, such as funding a wedding, consolidating debt, or making home improvements. Because they’re unsecured, the lender cannot seize your property if you fail to make repayments, though it can instruct debt collectors or take legal action.

Pros and cons of a personal loan

Advantages include:

• Unsecured: There’s no link to your assets, so your personal property, such as your home, isn’t at risk if you don’t make repayments

• Flexible:ÌýYou can use a personal loan for nearly anything, though you must be upfront about your reasons when applying

• Easy application: Applications can be processed within hours or days, depending on your financial situation, credit score, and reason for borrowingÌý

• Fast funding: The loan could be in your account within a day or two of approval

• Lower interest rates: Personal loans usually offer lower interest rates than credit cards, and the amount you can borrow is likely to be higher

Disadvantages include:

• Personal liability: You alone are responsible for repayments, and failure to repay can lead to debt collectors, legal action, and a damaged credit score

• Loan size: Personal loans are typically smaller than business loans

• Loan length: Repayment terms are typically shorter than those offered with business loansÌý

• Credit score: Using a personal loan won’t improve your business credit report

Can you use a personal loan for business purposes?

There’s nothing unlawful about using a personal loan for business purposes, but that doesn’t make it a good idea as you’re personally liable for the loan, rather than your firm. This means you and your credit report take the hit if there’s trouble with repayments.

From the lender’s perspective, if it lends to an individual who invests the loan into their business, it can only go after the borrower if repayments stop. It can’t recover what’s owed to them by seizing property that is owned by the business. This explains why lenders shy away from granting personal loans for business purposes.Ìý

If you do get one, ensure you’re upfront about what the loan’s for. Don’t make out it’s for home improvements if you’re really using it to pay for your office equipment. If the lender finds out, it can demand a full and immediate repayment.

Is it cheaper to get a business loan or a personal loan?

Business loans can be cheaper as lenders consider them less risky, due to strict eligibility criteria. Also, borrowers tend to benefit from longer repayment terms and lower interest rates, making monthly repayments easier.Ìý

However, as not all startups can get a business loan, the question of which is cheaper is redundant for many prospective borrowers. That doesn’t mean it’s not worth considering both options – it simply means you need to be confident that you can make a good case to the lender about:

• Why you need the loan

• How much you want to borrow

• The repayment term

• Your personal or business financial situation

• Your credit rating

What are startup loans?

If a business loan appeals but you’re not sure you’d meet a lender’s eligibility criteria, a government-backed Start Up loan may be worth considering.

An alternative to personal and business loans, this unsecured form of borrowing allows fledgling firms to borrow between £500 and £25,000 over one to five years to grow their business. The Interest rate is 6% for all borrowers, and you’re entitled to a year of free mentoring to help keep your business on track.