Starting a business is exciting. It’s also the lifeblood of capitalism and a bedrock of the American economy.
Money expert Clark Howard, a lifelong entrepreneur, loves talking shop with small business owners. And one challenge that small business owners face is securing a business loan with a good interest rate.
Should you look into borrowing on your personal credit instead?
Business Loan Options: Why Is My Lender Charging Me a Major Premium?
Should I borrow against my 401(k), my vehicle or my home in order to get a better interest rate to fund my small business?
That’s what a Clark Howard podcast listener recently asked.
Asked Kathy in Maryland: “I recently opened my own business, a yoga studio. We need working capital as the business continues to grow. I was approved for a business loan but due to the startup nature of the business, the interest rate is 17.99% and my husband and I would both have to sign as personal guarantors.
“The business is set up as C-corp, so I know I could deduct the interest on the loan; however, if I just wait until we’ve been in business six months, we should be able to get better terms.
“My accountant suggested that I use a HELOC but I’m not sure this is a good idea. I could also borrow against my 401(k) and/or take a secured loan out against our vehicle.”
Clark was going to yoga twice a week until shortly before a heart operation in December. He noted that he’s already feeling a loss of muscle mass, a tribute to how effective he believes yoga has been for his body. And he wished Kathy enormous success with her yoga studio for the difference it can make in people’s lives.
As far as securing a business loan with a competitive rate, he had to give Kathy a reality check. She’s not likely, as a small business owner in a service business, to avoid a major premium. Especially with a corporate structure that offers lots of legal protection.
“You’re not going to find that six months is going to make this better,” Clark says. “It’s a terrible problem with small businesses. Particularly service businesses.
“Lenders always want to do what’s called pierce the corporate veil. A business owned in a C-corp, there’s liability protection in it. And as a result, the lender wants someone to go after if a business loan goes bad. So they’re charging you 18%.
“That’s a terrible rate. And at the same time, it’s still a personal liability.”
Clark anticipates that Kathy will experience the same issue for years to come. Until she becomes a “big player,” perhaps with multiple yoga studios, they’ll see her liability-protected small business as a risk and charge a major premium.
Business Loan Options If You Need To Go Through Your Personal Credit
If you run a small business potentially with smaller margins, especially a new business that you’re trying to grow, it’s important to be realistic about your capital needs.
A sound, conservative business plan that projects a realistic timeline to profitability and properly assesses your financial risk based on the capital you’re putting into it is important.
Assuming that you’ve done well with those aspects, if you still need capital and you feel comfortable with the risk, consider turning toward personal loan options.
“I would follow the advice that you received from your accountant. And consider alternative loans,” Clark says. “There’s no reason you couldn’t get a much lower interest rate with some other method of borrowing that you’re personally responsible for.
“And [you can] still deduct that interest [on your taxes] because it is a legitimate business expense.”
Clark is not at all a fan of borrowing from your 401(k) account unless it’s an emergency. Borrowing against your vehicle also may not get you the amount of capital you’re hoping to inject into the business.
A HELOC is something to consider. Even though that’s a big risk.
“A home equity line, a HELOC, that is going to be the cheapest money you’re probably going to be able to come by that has a revolving credit line,” Clark says.
“The problem is you’re putting your home at risk. So if you do that, never take out so much money on a HELOC that you would put [yourself] at risk.”
Final Thoughts
Running a small business that protects you from liability through corporate structure? You aren’t likely to get great terms on a business loan.
You may need to source your personal credit to get a competitive interest rate. If you’re going to do that, a HELOC is probably a better option than borrowing against your 401(k) or your vehicle. Just be careful about putting your home at risk to inject capital into your business.
