Companies, especially smaller companies, sometimes stack loans to get the necessary capital to grow. Starting a profitable business can be difficult, and working without outside capital and building your business from the ground up with only your personal savings (called bootstrapping) is notoriously difficult.
With loan stacking, business owners can apply and be approved for multiple loans within days and sometimes hours, allowing them to draw on funds quickly. It works because the time between approving the loan and delivery of the funds is often much shorter than the time it takes to report the loan to credit-reporting agencies.
In theory, loan stacking sounds like a smart strategy for small businesses. But since each loan increases the debt burden on your business — which in turn increases the likelihood of default — loan stacking isn’t all it’s cracked up to be.
What Is Loan Stacking?
In a nutshell, loan stacking is taking out more than one loan without your creditors knowing it.
Perhaps you have office expenses, payroll, and rent to pay, but there’s not enough money. Or maybe you need more capital to pay for new inventory or an upgrade to your computer equipment. You head over to Acme Credit to take out a loan. You apply, but they approve you for a lesser amount than you need.
But applying for a loan is part of public record, so FasterLoans calls and says they can approve you for any money Acme doesn’t approve. If you take out the second loan from FasterLoans in addition to your first loan from Acme, you’re loan stacking, or having multiple loans on the books at the same time. Although FasterLoans doles out the money you needed, having the additional loan could become a problem for you — and for the first lender, who’s counting on you to be able to pay back their loan.
Is Business Loan Stacking Legal?
Loan stacking isn’t illegal, but many people frown upon it for obvious reasons. First, loan stacking often involves at least one party who’s engaging in fraudulent activity. For example, unscrupulous lenders sometimes falsely report the number of loans they’re servicing for a specific borrower to a credit bureau.
In some instances, you can find yourself dealing with a lender that uses high-pressure or dishonest sales tactics to convince you to take on more debt than you can possibly pay back. At other times, unscrupulous lenders contact you about “special promotions” shortly after you’ve secured an existing loan.
Likewise, you may make a hasty decision simply because you need more money than any single lender can provide or is willing to give you. Honest lenders try to ensure business owners aren’t stacking loans.
Different companies have different financing needs. Building websites from a home office doesn’t require much in terms of financing, while opening a food truck costs between $60,000 and $250,000, according to Food Truck Operator. And building a manufacturing plant or opening a car dealership can require millions for startup costs like a building, inventory, and licenses.
When a company applies for a loan, the lender takes everything into account, including known income, accounts receivable, accounts payable, debt, creditworthiness, and collateral. To ensure the applicant can pay back the loan, most lenders don’t lend more than a company can handle at the time based on their financial health.
But some lenders are more interested in profit and instead try to attract current loan holders with offers of additional capital.
How to Spot Unscrupulous Lenders That Allow Loan Stacking
Loan stacking makes business owners vulnerable to unscrupulous lenders who target companies with unsecured loans or merchant cash advances from other lenders. These unscrupulous lenders have organized their businesses to allow for — and even encourage — stacking by struggling business owners. They capitalize on another lender’s underwriting work by targeting people or businesses that have already gone through the first lender’s approval process. They care little for your financial well-being or about growing a strong business relationship.
Sometimes referred to as predatory lending, the goal of this practice is to write loans that might lure a borrower into a cycle of debt. They trick or trap borrowers into loans they can’t afford or don’t really understand. That often includes imposing abusive or unfair loan terms on borrowers.
Predatory lenders set a very high APR on loan packages, often lend too much money, and do scant or “soft” credit checks. A soft credit check is looking at information on a person’s credit report without impacting their credit score to prevent other lenders from seeing the full details of a borrower’s existing debt load.
The automated systems many of these lenders use can provide almost instantaneous loan denials or approvals based on the soft credit checks. A borrower can use the automated systems to take out multiple loans in succession without another lender finding out.
By contrast, honest and responsible lenders prohibit borrowers from stacking loans as part of their contract. They run in-depth credit checks on your company’s finances to ensure you aren’t borrowing more than you can handle. They only lend what fits into your business’s budget, making sure you can pay back the loan according to its repayment terms. They provide all the information you need to do your due diligence and make a fully informed decision about the loan. And they do all they can to earn your trust and build a good working relationship.
Reputable banks and most other financial institutions also have systems in place to guard against business loan stacking. However, it can take up to 30 days for their hard credit inquiries to show up on a credit report. That means a borrower can take out multiple loans from different lenders during this period without another lender knowing.
Why Loan Stacking Is Bad for Business
You need working capital to manage daily business operations, and some smaller or newer businesses need loans until their cashflow is sufficient to cover their expenses. But stacking business loans, while tempting, can actually worsen these common challenges for two reasons.
Loan Stacking Can Violate the Terms of Your Loan Contract
Responsible lenders are hesitant to lend large amounts of money to companies without a history of creditworthiness. And because lenders often file blanket liens — a lien on all or nearly all a business’s assets — stacking loans can violate the terms of your loan contract, forcing your loan into default.
For example, a struggling small business applies for credit and receives multiple loan offers. The first offer from Acme is for $30,000 — only half the money the business needs. The loan from Acme specifically restricts the borrower from applying for another loan until the $30,000 is paid in full. If the business accepts another loan from FasterLoans for the rest of the money, it’s in breach of its contract with Acme.
Loan Stacking Can Cause a Vicious Debt Cycle That Leads to Default
In times of need, it can be tempting to take as much as you can get. However, with each new loan comes an increased debt burden on your business. As your business’s debt burden grows, you’ll need to put an ever-greater share of your cashflow toward paying down your debt.
An analysis by Governing cites the sad example of a California bakery that put more than 25% of its daily cashflow (about $600) toward debt payments on four stacked loans. That’s money the bakery couldn’t invest in growth.
And a vicious debt cycle doesn’t just hinder growth. The higher the share of your cashflow going toward debt service, the higher your risk of defaulting on that debt. (That’s what happened to Governing’s debt-burdened bakery.) Defaulting has a number of serious and possibly fatal consequences for your business, including:
- Severely damaging your business credit score
- Putting your business assets at risk of liquidation (and potentially your personal assets if you’ve mixed your business and personal finances)
- Making the full balance of your loans due immediately and likely forcing your business to declare bankruptcy
Even if you don’t default on your loans or declare bankruptcy right away, breaking free from a vicious cycle of high-interest debt proves very difficult for most businesses. You’ll be dealing with the fallout from your decision to stack loans for years to come.
Alternatives to Business Loan Stacking
Seeking additional financing can be frustrating, especially if you’re a new business with little credit history. Fortunately, if you can’t get approved for a loan as high as you need, you have better options than loan stacking.
If your company needs more funds, work with your primary lender to explore these less risky financing options.
1. Asking Your Lender for More Money
If you’ve proven to be a good risk by paying off a decent chunk of your loan — typically around 50% — or you have a history of timely payments, many lenders are willing to extend you additional credit. You can use the extra funds to pay off old debt or finance a sudden expense, like a new roof on your current building.
If you do this, ask your lender if they can waive any remaining fees or interest charges on your existing loan. If not, you can get stuck “double-dipping” — paying new interest on new loans used to pay off old loans, or paying interest on interest.
2. Refinancing Your Loan
Let’s say you’re struggling with a high-interest loan you took out when you first opened your business. Your credit score was less than perfect, and you had a scant credit history.
But now, your business is booming, and you’re sure you can qualify for a low-interest loan with better rates and fees. You’ll use this new loan to pay off your existing high-interest loan.
This process is known as refinancing. The advantages of refinancing include:
- Shorter loan term
- Lower payments
- The ability to switch from a fixed-rate loan to a variable loan or vice versa
- Paying off the old high-interest loan
But refinancing can have some disadvantages:
- High transaction costs
- Higher interest payments if you stretch out the loan payments over a longer period
Make sure you weight the pros and cons of this strategy to decide if it’s right for you.
3. Apply for a Line of Credit
Much like small business credit cards, lines of credit are there to help when you need a little extra cash to pay a few bills or hire your first employee. You can’t always count on your customers to pay on time, so a line of credit ensures you never find yourself squeezed for cash.
A line of credit gives you access to funds on demand, often with higher limits than business credit cards. (BlueVine underwrites lines of credit as large as $250,000, for example.) You can draw on it up to a maximum amount over a set period. You pay interest only on the money you use, and once you pay it back, that amount is available to draw on again.
Unlike credit cards, your credit line is generally much higher, although both set limits based on creditworthiness. And a loan doesn’t offer as much flexibility as a line of credit does when it comes to how you make monthly payment. You choose when to borrow, when to pay it back, and when to borrow again — just as long as you stick to the terms of the line of credit.
Loan stacking can be tempting. But the promise of significant sums of money spread over a few loans is usually too good to be true. High interest rates and mounting debt are difficult to manage for most small businesses. In most cases, loan stacking places your business in serious financial jeopardy.
Some higher-risk lenders even promote loan stacking for debt consolidation. But most legitimate lenders believe it puts small businesses at risk of default while undermining the entire industry.
Even with the pitfalls and risks laid out, some small-business owners continue to borrow on multiple loans as long as lenders grant approval. But at some point, you must pay back the principal. That’s when your hard work and dreams for success can hit a dead end.