When the pressure mounts in your personal life, it’s tempting to use a business loan to clear your debts. But is that a good idea?
As a business owner, you’re juggling all sorts of financial obligations. You have employees and stock to consider. Your taxes have to be correct and you need to manage your business cash flow.
That’s enough stress on its own.
But then you factor in your personal life. You likely have a mortgage and living expenses to deal with. Perhaps you even have other debts that are starting to get on top of you.
That’s when the temptation strikes.
You start asking yourself: “Can a business loan be used for personal expenses?” There are various financing options available to business owners, each with its own intended use.
The trouble is that this is a bit of a grey area. You could end up on thin ice if you use unsecured business loans for personal reasons. It depends on how you’ve set up your business.
This article examines what you can and can’t do with your business loans on a personal level.
Understanding the Types of Business Loans
When it comes to business finance, choosing the right type of business loan can make a significant difference in your company’s financial health and growth potential. Business loans come in many forms, each designed to meet different needs—whether you’re looking to manage cash flow, cover start up costs, purchase equipment, or invest in commercial property. Understanding your options is the first step to making a smart borrowing decision.
Secured Business Loans
Secured business loans are a popular choice for businesses that need to borrow larger amounts of money or want access to lower interest rates. With a secured loan, you’ll need to offer collateral—such as commercial property, equipment, or other physical assets—to back the loan. This gives lenders more confidence, often resulting in more favourable loan terms and lower interest rates. For example, if you’re planning a business acquisition or want to buy vehicles for your company, a secured loan can provide the lump sum you need, using the purchased assets as security. However, keep in mind that if you’re unable to repay the loan, the lender can claim the collateral to recover their money.
Unsecured business loans are ideal for businesses that don’t have assets to offer as collateral or need quick access to funds. These loans are typically used for short term needs, such as covering start up costs, managing cash flow, or paying for unexpected expenses. Because there’s no collateral involved, unsecured loans usually come with higher interest rates and shorter loan terms. For instance, a small business might use an unsecured loan to pay suppliers or cover payroll during a slow season. While unsecured loans can be more expensive, they offer flexibility and faster approval times, making them a valuable option for many business owners.
Equipment Finance
If your business relies on up-to-date machinery, vehicles, or technology, equipment finance can help you stay competitive without draining your working capital. Equipment finance allows you to borrow money specifically to purchase new equipment, often using the equipment itself as security for the loan. This type of business loan can be structured as either a secured or unsecured loan, depending on the lender and the value of the equipment. For example, a construction company might use equipment finance to buy a new excavator, spreading the cost over several years while keeping cash flow steady.
Invoice Financing
For businesses that regularly deal with outstanding invoices, invoice financing can be a lifeline. This type of business loan lets you borrow money against the value of your unpaid invoices, giving you immediate access to funds while you wait for customers to pay. Invoice financing is especially useful for businesses with long payment cycles or seasonal fluctuations in income. For example, a wholesaler with a large number of outstanding invoices might use invoice financing to cover operating expenses or invest in new inventory, without waiting weeks or months for payments to come in.
Key Considerations
Before you borrow money, it’s important to weigh your options carefully. Here are some key factors to consider when comparing business loans:
- Interest rates: Shop around and compare interest rates from different lenders to ensure you’re getting the best deal for your business.
- Repayment terms: Look at the length of the loan term and the various repayment options available. Make sure the schedule fits your business’s cash flow and financial situation.
- Collateral requirements: Determine if the loan is secured or unsecured, and what type of collateral (if any) is needed.
- Credit history: Check your business credit score and financial statements. A strong financial position can help you qualify for better loan terms.
- Financial position: Be realistic about your ability to repay the loan. Consider your net income, outstanding invoices, and overall financial health before committing.
It’s always wise to seek professional advice and review your financial statements before making a decision. Understanding the different types of business loans—and how they fit your business needs—can help you access the funding you need to grow, manage cash flow, and achieve your goals.
It Comes Down to Your Business Structure
When you created your business, you had to choose a structure for it. Your options included:
- Sole Trader
- Trust
- Partnership
- Company
When applying for a business loan, having a solid business plan is often required, as it demonstrates the viability of your business to lenders.
You may not have considered unsecured business loans when making your decision. For example, you may have set up as a Sole Trader because you have no employees. Or you may have set up as a company to protect your personal assets from business liabilities.
Basically, your structure determines if you can use a business loan for personal expenses.
We’re going to focus on the company and sole trader structures in this article.
How Does Registering as a Company Affect You?
The facts are simple. If you structure your business as a company, especially as a private company, you can’t use a business loan for personal expenses. Private companies are subject to specific tax laws regarding loans to directors and shareholders, including Division 7A of the Income Tax Assessment Act 1936.
The same goes for business credit cards and other lines of credit.
Here’s how it works.
When you set up a company, you create a new legal entity. That means it’s completely separate from you as a person. Companies must comply with tax law when making loans to directors or shareholders, and any loans must be properly documented and structured to avoid adverse tax consequences.
As a director or owner of the company, you pay yourself a salary. However, you can’t just withdraw funds from a company bank account for personal use. If companies lend funds to directors or shareholders, a formal loan agreement must be in place, specifying the loan amount, interest rate, and repayment terms. The money the business takes in belongs to the corporation – the legal entity you created – not you.
How does this affect you when you ask for a business loan?
When a lender approves your business loan, they do so based on the case you made for the company. You’re borrowing money for the legal entity you created, rather than yourself. That money goes into the company bank account, which makes it the property of the business. It is important for companies to maintain a loan account to track any loans made to directors or shareholders, ensuring compliance with Division 7A and other tax law requirements.
Now, you may be able to use that money to pay your salary. But you can’t just take it out of the business to pay for your personal expenses. When borrowing money for the company, the borrower is the company itself, but borrowers can also include directors or shareholders if they receive funds from the company under a loan agreement. The Income Tax Assessment Act governs how private companies make loans to directors or shareholders, and it is crucial to comply with tax law when structuring and repaying these loans. If a company forgives a loan, this may be considered debt forgiveness and could have tax implications. A loan is considered paid when the funds are transferred to the borrower, which affects the timing of tax obligations. The income year is relevant for determining when loans are made and repayments are due. The benchmark interest rate is used to calculate minimum repayments for Division 7A compliance, and the interest rate on company loans must meet or exceed the benchmark interest rate to avoid being classified as a dividend. The loan amount must be documented in the loan agreement, and other loan types, such as advances or payments, may also be subject to Division 7A rules. Companies may have multiple loans to directors or shareholders, so consolidating or tracking them is important for compliance. In certain circumstances, repayments may be allowed by a later date, as long as they meet Division 7A requirements. A loan is considered fully repaid when all principal and interest have been paid according to the loan agreement.
Think of it as taking money from another person to pay your debts. It’s simply not a legal use of the money you’ve borrowed.
What About Company Credit Cards?
The same goes for your company credit cards.
If you charge a personal expense to your company card, you’re not keeping a proper separation between yourself and the business.
You might even find yourself personally liable for money the business owes. The courts may decide business creditors can use your personal assets to pay off company debts.
You miss out on one of the main benefits of creating the company structure in the first place.
Beyond this, you create tax issues due to this mingling of business and personal. You’re also raising doubts about how your business uses its funds.
Other lenders, such as banks, may offer secured loans as an alternative to credit cards for business-related expenses, often with different terms and repayment periods. Keep in mind that using credit cards or unsecured loans typically comes with a higher interest rate compared to secured loans, increasing the overall cost of borrowing. Additionally, some business credit products, including certain credit cards and loans, may have variable interest rates, which can affect your repayment amounts over time.
Finally, using your company credit card may impact both your personal and business credit scores. You may find it more difficult to get an unsecured business loan in the future if you’re charging a lot of personal expenses to the card.
How Does Registering as a Sole Trader Affect You?
You may get some happy news here.
It’s possible for you to use a business loan for personal expenses if you’re a sole trader.
There’s a reason for this. Sole traders don’t have to set up a separate legal entity when creating their businesses. They don’t even need to create a business bank account if they don’t want to.
Sole traders have flexibility in how they use business loans, with term loans and short term loans being common options for those seeking funding. Business loans can be used for a variety of purposes, such as purchasing inventory or commercial real estate purchases, depending on your business needs. In some cases, residential property may be used as collateral for certain types of business loans available to sole traders.
That means you’re free to use a business loan for personal expenses from a legal standpoint. It’s important to speak to your lender about this. They may take issue if you applied for the loan for one specific reason and then use it for another.
Here’s the key thing to remember. Any money you take from the business becomes taxable income for you personally. So if you use $5,000 of a loan for personal expenses, you have to declare that as income on your personal taxes.
Again, this can muddy the waters a little bit.
You don’t have to worry about exposing your personal assets by using this money. As a sole trader, that’s something you’re already doing.
You’re Navigating Murky Waters
So, can a business loan be used for personal debts and expenses?
It can if you’re a sole trader, but not if your business has a company structure. Corporations are separate legal entities and you need to treat them as such.
Even as a sole trader, you’re navigating some pretty murky waters. You’re legally able to use any money that comes into the business for personal expenses. But you may face issues with your lender if you’ve told them you need the money for something else.
The safest bet is always to keep your business and personal finances separate. This ensures you’ll face no legal issues. Plus it makes managing your finances easier.
It may be best to go with a personal loan for your own needs. But if you need an unsecured business loan, we can help you.
Apply online today. It only takes five minutes and you’ll receive a quick response to your application.
This article is for informational purposes only and does not constitute tax advice. Please consult a qualified professional for personalized tax advice.
