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. If you have a home loan, it’s important to note that lending legislation, such as the Credit Contracts and Consumer Finance Act, provides specific protections and requirements for home loans that differ from those for business loans. 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?”
In situations like this, it may be worth considering personal loans as an alternative option for covering personal debts, since they are designed for individual expenses and are often easier to obtain than business loans. Before deciding, think about whether using a business loan for personal debts really makes sense for your current financial situation. Using a business loan to pay off personal debt is generally not advisable and could lead to legal or financial complications. Some business owners also use their own money to cover business or personal expenses, which can show commitment but also puts personal assets at risk. When taking out a personal loan, you are obligated to repay the full amount borrowed, including interest and fees, and you should carefully review the terms to understand how much you will need to pay back according to the contract.
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 Can a business loan be used to buy a house? what you can and can’t do with your business loans on a personal level
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
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. However, business loans are generally intended to be used for business purposes, not for personal spending. Additionally, only qualifying businesses may be eligible for certain types of loans or permitted uses, depending on the lender’s criteria. Business loan applications are often assessed based on the business’s potential future profits and cash flow, rather than just personal financial information.
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 you can’t use a business loan for personal expenses.
The same goes for business credit cards and other lines of credit, including a business line of credit. There are strict restrictions on using a business line for personal debts, and misusing business credit can have serious consequences.
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.
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. You have to use that money for the business. 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. The loan should be used for a legitimate business expense, not for personal use.
When applying for a bank loan, you will typically need to prepare a comprehensive business plan that outlines your company’s goals, financial projections, and repayment strategies. The application process often requires detailed documentation and a thorough review of both your business and personal credit history. Lenders use this information to assess your creditworthiness and determine the terms of the loan.
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. The funds must be used for business expenses only.
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. If a lender finds that you have used business credit for personal expenses, they may recall the loan or impose penalties for breaching the loan agreement.
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. Only legitimate business expenses are tax deductible, so mixing personal and business charges can lead to disallowed deductions and increased tax liability. You’re also raising doubts about how your business uses its funds.
Finally, using your company credit card may impact both your personal and business credit scores, as well as negatively affect your personal credit history and credit rating. 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. However, using a personal bank account for business transactions can make it harder to track expenses and may lead to missed tax deductions or other disadvantages.
That means you’re free to use a business loan for personal expenses from a legal standpoint. As a sole trader, you can apply for a small business loan, but you should carefully consider the interest rate and understand the application process. If you are using the loan to purchase business assets or equipment, make sure to document the purchase for accounting and tax purposes. 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. Making timely loan payments is also important to avoid additional fees and higher interest charges.
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.
Cash Flow Management: The Real Reason to Keep Business and Personal Finances Separate
Effective cash flow management is at the heart of every successful business, and one of the most important steps you can take is to keep your business and personal finances completely separate. This isn’t just about making tax time easier—it’s about having a clear picture of your business’s financial situation at all times, which is essential for making smart decisions and protecting your personal assets if your business faces debt.
When you apply for a business loan, lenders and financial institutions want to see that your business is well-organized and financially sound. This means having separate accounts for business and personal transactions, which makes it much easier to prepare accurate financial projections, such as cash flow forecasts and profit and loss statements. These documents are crucial when seeking bank loans, unsecured loans, or other funding options, as they help lenders assess whether your business can handle loan repayments and manage unexpected expenses. It’s also important to understand the total cost of a loan, including interest, fees, and any additional charges, so you can make informed decisions and avoid unexpected financial strain.
Keeping your finances separate also safeguards your personal credit. If your business needs to borrow money, using a business loan instead of a personal loan ensures that your personal credit score isn’t directly impacted by your business’s borrowing activities. This is especially important for small business owners who may need to provide a personal guarantee for secured loans. By maintaining a clear boundary between business and personal finances, you reduce the risk of your personal assets being at stake if the business encounters financial difficulties.
In New Zealand, where small businesses and established businesses alike face a competitive market, effective cash flow management is key to staying resilient. Whether you’re exploring government grants, equity crowdfunding, or traditional bank loans, having a well-managed financial position can help you secure lower interest rates, better loan terms, and more flexible repayment options. There are various types of finance available to businesses, including short-term loans, lines of credit, and asset-based finance, each with its own features and requirements. For new businesses, understanding the importance of this separation from the start can make a significant difference in accessing borrowing options and building a strong foundation for growth. If you’re looking to make your business loan application simple, following certain steps can further increase your chances of success.
Ultimately, separating your business and personal finances isn’t just good practice—it’s a strategic move that can help your business idea thrive. It protects your personal assets, strengthens your business’s credibility with lenders, and makes it easier to manage your money as your business grows. For business owners in New Zealand and beyond, this approach is essential for long-term success and for making the most of every funding opportunity that comes your way.
Consumer Laws and Business Loans
When considering business loans, it’s essential for business owners to understand the consumer laws that protect their interests. Legislation such as the Consumer Guarantees Act and the Fair Trading Act play a significant role in ensuring that lenders treat borrowers fairly and transparently. For example, the Consumer Guarantees Act requires that all financial services, including business loans, meet certain standards of quality and reliability. This means that lenders must provide clear information about the loan, including the interest rates, fees, and repayment terms, so borrowers can make informed decisions.
The Fair Trading Act further protects business owners by prohibiting misleading or deceptive conduct by lenders. This includes ensuring that all advertising and sales techniques used to promote business loans are honest and accurate. If a lender fails to disclose important details—such as how interest rates are calculated or what happens if you miss a payment—they could be in breach of these consumer laws. As a business owner, being aware of your rights under these acts can help you avoid falling victim to unfair practices and ensure you receive a loan that meets your business’s needs.
By understanding the protections offered by the Consumer Guarantees Act and the Fair Trading Act, borrowers can confidently navigate the business loan process, knowing that there are rules in place to safeguard their interests. Always take the time to read the fine print and ask your lender for clarification if anything is unclear—these laws are there to support you in making the best financial decisions for your business.
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. As a small business owner, understanding your eligibility for different types of loans is crucial.
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. For example, using a business loan to pay for a family holiday or personal debts could breach your credit contract and result in penalties. Other examples include using business funds to purchase personal items like washing machines, which may not be allowed as collateral for secured loans.
The safest bet is always to keep your business and personal finances separate. This ensures you’ll face no legal issues and helps maximize your personal income by keeping business expenses and deductions clear. Plus it makes managing your finances easier and pays off in the long run by avoiding confusion with tax liabilities.
To ensure you get the best deal for your situation, compare different loan options and consider personal loans for your personal needs. You may also want to explore other lenders, such as credit unions or online financial service providers, to find the best terms. Always seek professional advice before making any decisions or signing credit contracts, as understanding the terms is essential. It may be best to go with a personal loan for your own needs, but business loans are ideal for business expansion, purchasing inventory, or helping you sell products to your customers.
When choosing a lender, make sure they are a registered financial service provider and that you understand your rights under the Consumer Finance Act and other relevant legislation. The Commerce Commission regulates lending practices and enforces consumer protection and consumer rights, ensuring fair treatment for borrowers. Product safety and fair trading laws also apply if you sell products or provide services to customers.
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Dispute Resolution and Business Loans
Even with strong consumer laws in place, disputes between business owners and lenders can sometimes arise. That’s where dispute resolution services come in. In New Zealand, organizations like the Financial Service Providers Register and the Financial Markets Authority play a key role in helping resolve conflicts related to business loans. These financial service providers offer structured processes to ensure that both borrowers and lenders are treated fairly and that any disagreements are addressed promptly.
If you find yourself in a dispute with your lender—perhaps over the terms of your loan, the way interest rates were applied, or the service you received—it’s important to know that you have options. The Financial Service Providers Register ensures that all lenders are properly registered and meet certain standards, while the Financial Markets Authority oversees the conduct of financial service providers to protect borrowers’ interests. Through these organizations, you can access dispute resolution services that are designed to be impartial and effective.
For business owners, understanding how the dispute resolution process works can provide peace of mind. If you believe your lender has acted unfairly or breached the terms of your agreement, you can lodge a complaint and have your case reviewed. This process can lead to compensation, changes to your loan terms, or other remedies, depending on the outcome. By being proactive and informed, you can ensure that your rights as a borrower are protected throughout the life of your business loan.
Business Loan Alternatives
Traditional business loans aren’t the only way to access funding for your business. There are several business loan alternatives that may better suit your needs, especially if you’re concerned about higher interest rates or strict repayment terms. For example, invoice financing allows businesses to borrow money against their outstanding invoices, providing quick access to cash without waiting for customers to pay. This can be a great option for businesses with a steady stream of sales but slow-paying clients.
Another alternative is a merchant cash advance, which provides funding based on your future sales. This type of financing is often easier to qualify for than traditional loans, but it can come with higher interest rates, so it’s important to carefully review the terms before committing. Peer-to-peer lending is also gaining popularity, connecting borrowers directly with investors through online platforms. This can sometimes result in lower interest rates and more flexible terms, especially for businesses with a strong credit history.
When exploring these alternatives, it’s crucial to compare the costs, benefits, and risks of each option. For example, invoice financing may be ideal for businesses with many outstanding invoices, while peer-to-peer lending could be better for those with solid credit and a clear business plan. By considering all your funding options, you can find the solution that best fits your business’s needs and avoid the potential pitfalls of traditional business loans, such as higher interest rates and rigid repayment schedules. Always take the time to research and consult with financial service providers to ensure you’re making the best choice for your business’s financial health.
