Instead, understand the pros and cons of using a personal line of credit. That way, you’ll be equipped to:
- Understand if this financing option is right for you.
- Know how to best utilize it.
- Compare it to other business financing options.
To Review, a Personal Line of Credit Works Like This:
After opening an account with a financial institution, you get immediate and ongoing access to a certain amount of money (a credit limit) for an agreed-upon time-frame. It’s flexible because you can access the money and pay it back as soon as you like. Remember, though, since it’s a loan, you’ll be charged interest on the money you borrow!
The Pros of Using a Personal Line of Credit for Business:
1. Pay Your Business's Bills Quickly
You may have a payment of $500,000 coming in next month, but without that cash on hand to pay your monthly rent, you’re in trouble. With a personal line of credit, you have immediate access to cash that you can use how you want, when you want.
2. Less Red Tape than a Business Line of Credit
Business lines of credit tend to have more stringent requirements than personal lines.
NerdWallet has found that traditional lenders usually “require businesses to have strong revenue and at least a few years of history to qualify for a [business] line of credit.”
Should you go for a personal line of credit or personal loans instead, you won’t face as much scrutiny.
In a
Bankrate article, Brent Vallat, Senior Vice President at Wells Fargo said “underwriters are likely to approve borrowers with a strong credit history, a good relationship with the bank and verifiable earnings.”
3. Pay Only for What You Use
With a term loan, you’ll be given a set amount of money,
unlike a personal line of credit. Instead of paying interest on a lump sum of money, you only pay interest on the money you use. That’s why a line of credit is such an effective tool for evening out cash flow.
With a line of credit, you have security in knowing that anytime you need cash, you can tap your line of credit to bridge the gap. It’s like a cash flow insurance policy. The best part? Unlike insurance, there’s no monthly premium with a personal line of credit.
The Cons of Using a Personal Line of Credit for Business:
1. Can Be Damaging If Used Improperly
You wouldn’t use a toaster oven to make coffee, right? Well, that’s essentially what some people do with personal lines of credit. Instead of using it for the occasional cash flow shortfall, people may use it to, for example, pay for a vacation they can’t afford.
With a personal line of credit, you must be very careful deciding when and how you plan to use it. Otherwise, you run the risk of getting stuck with high interest debt.
2. Mixes Personal Funds with Business Finances
You should tread lightly when mixing personal credit (and cash) into your business. It can cause problems when filing your taxes, especially if you’re not diligent about keeping personal and business expenses separate.
Moreover, when you use a personal line of credit, you run the risk of damaging your personal credit score. This is especially true if you use most of the funds available through your line of credit, because your credit utilization score will rise.
3. More Expensive than Traditional Secured Loans
Personal lines of credit are
unsecured, meaning you don’t need to put up collateral to secure the loan. Due to this, lenders can’t easily seize your assets for your failure to pay, so they’ll charge more in interest than they would for a traditional secured loan.
Conclusion: Consider Your Business's Future
You should approach using a personal line of credit for business expenses with caution and due diligence. It’s an extremely effective tool when used properly. Plus, if you pay back what you borrow in full and in a timely manner, you’ll build your personal credit. If you have a good personal credit score, it’ll boost your chances of
qualifying for a business line of credit, so you won’t have to utilize a personal line of credit for business expenses.
Remember, there are other financing options aside from lines of credit that you can pursue. Consider business credit cards, traditional loans, cash advances, and sba loans as well. By doing research, you'll be able to receive the right financing option for your small business!
Editor’s Note: This post was updated for accuracy and comprehensiveness in February 2019.