Thinking about accepting more than one business loan? This practice, known as “loan stacking,” may seem like a simple way to get business funding when a single lender doesn’t provide all the cash you need. However, it’s usually a terrible idea that can harm your business for years and may even cause irreparable damage. It is also crucial to consider whether loan stacking is a crime, as this could add legal risks to the financial ones. On this page, we’ll cover the risks when you take out multiple loans and alternatives to loan stacking so that it’s easier to make the right decision for your business’s long-term health.
What is Loan Stacking and How Does it Happen?
Only about half of all small businesses that apply for funding receive the full amount, according to the latest Small Business Credit Survey. Obtaining business financing becomes even more challenging when the economy is uncertain or during a lender retreat.
At the same time, it’s quite common for businesses to apply for loans through marketplaces or request funding from many lenders at a time, hoping to increase the odds of being fully funded. This often results in offers from different lenders. When a business accepts more than one loan offer, it’s called “loan stacking.”
The business wouldn’t likely qualify for both loans if they were requested independently at separate times. However, because the credit check is performed before either of the loans are accepted, neither loans shows up on a report.
It makes sense that borrowers are often tempted to accept more than one loan, given how difficult it is to get approved for small business funding. Even still, the risks of loan stacking typically outweigh the benefits, though borrowers may not be aware of the consequences right away.
Risks of Loan Stacking: Why Multiple Business Loans May Lead to Trouble
Many people start by asking, “Is loan stacking fraud?” or “Is loan stacking a crime?” Generally speaking, loan stacking is not a crime. It is considered fraud if you lie to either lender about the other. However, loan stacking, as the practice is described here, does not involve deception and is therefore not illegal. Even still, it’s one of the worst things you can do for your business for the reasons outlined below.
Multiple Loans Increase Your Risk of Default
The strain of debt is already being seen across the country, with nearly one-third of small businesses reporting that it’s challenging to keep up with debt payments, per the Small Business Credit Survey. Two in five owe more than $100,000.
Lenders understand this, which is why they consider how much debt your business already has and your ability to make payments toward a loan before you’re approved. These steps reduce the default risk, protecting both you and the lender.
When you stack loans, you’re increasing your payments and your debt ratio, which increases the likelihood of default.
Loan Stacking May Violate Your Original Loan Agreement
Lenders often include loan stacking clauses or have guidelines related to collateral. For instance, if you obtain an asset-based loan and leverage real estate as collateral, the lender has the lawful right to liquidate the property if you default on the loan. Most lenders include language in their contracts that indicates they receive payment first if the asset is liquidated. If you have two lenders offering funds based on the same asset, the combined loans likely exceed the asset’s value, meaning one of them isn’t likely to be repaid if you default.
This situation makes lenders uneasy for obvious reasons, so one or both may consider this a breach of contract and demand full repayment immediately.
Your Credit Score Will Take a Hit
Your business credit score is comprised of several factors, including your payment habits, credit utilization, outstanding balances, and ongoing trends. Because loan stacking is most often done by businesses that don’t have strong credit to begin with, your credit utilization and outstanding balances will likely decrease your score dramatically. You’ll also have two new loans rather than one, which can make you seem riskier to lenders. Plus, it’s unlikely you’ll be able to keep up with monthly payments under these conditions, which decreases your score even more.
As your credit score drops, your future loan prospects do as well. A bad credit score also impacts your trade credit access, interest and cost to borrow, insurance premiums, and rent. In other words, your business will become less profitable, making it even more difficult to manage cash flow.
Additional Loans Will Have Higher Interest Rates
If you don’t receive full funding from a single lender, chances are that you’re considered a subprime borrower. This may mean you have a low credit score or lenders feel you’ll have difficulty maintaining your repayment schedule for other reasons. Businesses that fit into this category pay considerably more to borrow.
For instance, those with good credit are usually offered business loans with interest rates that top out at around 20 percent. A well-qualified business may even see interest rates of around seven percent. Conversely, businesses with bad credit can see interest rates around 35 percent or higher. You’re also likely to see higher fees tacked onto your loans.
Let’s explore what a typical loan might look like and what happens when you stack loans. In both examples, your business receives $50,000 with five-year terms.
Traditional Business Loan Example
- Loan Amount: $50,000
- Interest Rate: 10% (15.9% APR)
- Loan Term: 5 years
- Origination Fee: 5%
- Documentation Fee: $750
- Monthly Payment: $1,062.35
- Total Payback: $63,741.13
- Cost to Borrow: $16,991.13
Stacking Business Loans Example
Loan 1
- Loan Amount: $30,000
- Interest Rate: 25% (28.98% APR)
- Loan Term: 5 years
- Origination Fee: 5%
- Documentation Fee: $750
- Monthly Payment: $880.54
- Total Payback: $52,832.38
- Cost to Borrow: $25,082.38
Loan 2
- Loan Amount: $20,000
- Interest Rate: 27% (31.79% APR)
- Loan Term: 5 years
- Origination Fee: 5%
- Documentation Fee: $750
- Monthly Payment: $610.71
- Total Payback: $36,642.39
- Cost to Borrow: $18,392.39
Loans 1 and 2 Combined
- Loan Amount: $50,000
- Monthly Payment: $1,491.25
- Total Payback: $89,474.39
- Cost to Borrow: $39,474.39
Traditional Loan vs. Stacked Loans
Even though the loan amount doesn’t change, the business with stacked loans pays $428.90 more each month because they’re paying additional interest and fees. Over the five-year term, the cost to borrow is $22,483.26 more for the business with stacked loans too.
You Can Get Trapped in a Negative Cycle of Debt
As you can see, stacking loans can become very expensive, which is unfortunate because the businesses that stack loans tend to be the most cash-strapped. To keep up with payments, they often seek out additional forms of funding.
At this point, however, the business is a high-risk borrower. That means it doesn’t qualify for most traditional loans, and the fees and interest are even higher if it does. Many are pushed into costly loan alternatives, like merchant cash advances (MCAs), with APRs that climb to 100 percent or more.
When faced with these extremes, it is tough to dig yourself out of debt. Sadly, many small businesses don’t and end up closing.
Alternatives to Loan Stacking for Small Business Owners
While loan stacking isn’t illegal, it’s seldom advantageous for your business, often resulting in more harm than benefit. When you’re in a situation where you feel the need to stack loans, it’s crucial to remember that this approach can complicate your existing loan obligations and make it more challenging to manage your finances. Stacking loans means taking out another loan on top of an existing one, which can lead to a tangled web of debt that’s difficult to navigate. Before you consider loan stacking, think about the impact it will have on your ability to pay back your current loans. Often, businesses that stack loans find themselves in a precarious financial situation, struggling to keep up with multiple repayments. If you’re considering loan stacking because you need more money, it’s worth exploring other options. There are alternatives to taking out another loan that might be more beneficial in the long term. It’s important to carefully review your loan contract and understand the implications of adding more debt to your portfolio. Remember, while loan stacking is not illegal, it’s generally bad for your business’s financial health and should be approached with caution.
Ask Your Current Lender for Help
Have a frank conversation with your current lender about how much you need and how you intend to leverage the cash. They may have alternate programs or be able to increase your loan amount. Explain the context in which you’ll be using the cash, highlighting your ability to repay the loan, which is a key consideration for lenders. Discussing your financial stability and repayment plans can build trust and might lead them to considering alternate programs that could benefit you. Additionally, if your needs extend beyond the current loan amount, don’t hesitate to discuss the possibility of additional funding. By clearly saying what you need and demonstrating a solid repayment plan, you increase the chances of your lender being receptive to increasing your loan amount or offering alternative financing solutions.
Explore Refinancing Options
Refinancing or consolidating your loans into a single loan with a lower interest rate and payment may be a viable solution for businesses that still have good credit and those that have paid down at least some of their debt. Particularly for businesses that maintain good credit standing and have successfully paid down a portion of their existing debt, this approach offers a viable solution. It involves the applicant applying for a new line of credit, which consolidates multiple debts into one, potentially with more favorable repayment terms. This not only simplifies the debt management process but also may provide an opportunity to break free from the burdensome debt cycle. By securing a single loan with a lower interest rate, businesses can align their debt obligations more closely with their ongoing business needs, leading to better financial health and stability.
Avoid Loan Stacking with Invoice Factoring
Invoice factoring is a unique funding solution that accelerates payment on your B2B receivables. Instead of applying for a loan, you’ll sell your unpaid invoices to a third party, known as a factor or factoring company. The factoring company then sends you most of the invoice’s value right away. When your client pays, the factor sends you the remaining sum minus a small fee, usually between one and five percent of the invoice’s value.
Factoring can help you bridge cash flow gaps, so you don’t need to take out loans from lenders. Plus, you have no debt to repay, so it doesn’t have the same negative consequences as loans. It’s particularly beneficial in specialized industries, where steady cash flow is critical for managing operational expenses like payroll and vendor payments. For instance, factoring for security companies can cover recruiting, training, and labor costs even though the client may not pay for months. Plus, you have no debt to repay, so it doesn’t have the same negative consequences as loans.
Request a Complimentary Factoring Rate Quote from Charter Capital
With decades of experience helping businesses like yours and competitive rates that keep more money in your pocket, Charter Capital can help your business cover expenses and grow without accruing debt. To learn more or get started, request a complimentary factoring rate quote.
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