The line between personal and business finance is extremely blurry when it comes to small businesses and entrepreneurs. According to the Federal Reserve’s latest Small Business Credit Survey, 11 percent of small business owners use personal loans to finance their companies and 45 percent only use their personal credit score when applying for financing.
Using your personal credit to finance business expenses is often the only option for new and small companies without many assets or an established business credit history. However, it is important to compare multiple lenders before you make a choice.
Too many business owners go with the first lender that approves their applications because they are either too busy to apply to multiple lenders or they feel that all lenders offer similar rates to people with their credit score and income.
This can be an expensive mistake.
The price dispersion of personal loans
A recent study by SuperMoney, a financial services site, analyzed nearly 160,000 loan offers to over 15,000 borrowers who recently applied for a loan. It found that the average difference between the highest and lowest APR offer (for the same borrower and loan term) was 7.1 percentage points.
The potential savings on even modest loan amounts are huge when the range of rates is so broad.
In 2019, Americans held a balance of $148 billion in personal loans. Even a modest variation in interest rates could have a significant impact on the debt of American consumers. To illustrate, let’s assume that $148 billion balance has an average term of 36 months and a 13.5 percent APR. Dropping the average APR by only 3.5 percentage points to 10 percent would save Americans $3 billion a year.
Consider one borrower in the study’s dataset that had a credit score of 720 and applied for a $30,000 loan with a 36-month term. The lowest APR offered was 5.99 percent APR and the highest was 15.87 percent. This price dispersion on a $30,000 loan translates into savings of up to $5,050 — or 17 percent of the loan balance.
It is worth emphasizing again that this price dispersion is for loan offers to the same consumer.
Comparing multiple lenders when shopping for a personal loan to finance your business is a smart idea no matter what your credit score is. However, the study showed that borrowers with fair (580–669) and good credit (670–739) had the most to gain from comparing multiple lenders. Both credit score brackets had a price dispersion of 8 percentage points.
That does not mean that comparing lenders is not important when you have excellent credit. According to the same SuperMoney study, failing to compare multiple lenders could save borrowers with very good credit more money than increasing their credit score by 100 points.
Every year, Americans waste billions of dollars on inflated interest rates. Many borrowers only check one or maybe two lenders.
There are several reasons for this. For starters, applying for multiple loan quotes is tedious and time-consuming. Borrowers often think it is a waste of time to compare prices because they assume all lenders have similar rates for people with their credit score.
Some also worry that applying for multiple loans will hurt their credit score. They are not wrong. Every time you get a hard pull on your credit report, your credit score will probably drop by a few points.
The good news is that many lenders allow you to prequalify and check your rates with a soft credit pull, which will not ding your credit score. There are also fintech companies that are reducing search frictions and price dispersion by making it easier to compare mortgages, auto loans, and unsecured personal loans.
Next time you get a personal loan to finance a new startup or business investments do yourself a favor and invest just a few minutes of your time comparing prices. There is no upside to paying more than you have to for a business loan. Just spending a few minutes comparing the loans you qualify for could save you thousands of dollars over the life of the loan.