Last updated on June 3rd, 2021 at 06:40 pm
Business owners find themselves in need of finances to meet their working capital needs as well as other expenses. Unfortunately, banks and other lenders are usually not willing to extend small businesses credit due to a lack of collateral and higher chances of default if the business fails.
Due to this, small startups are at times driven into a situation where they get several loans from different lenders within the same period and almost on the same terms, which is referred to as loan stacking.
Defining Loan Stacking
Loan stacking refers to when a borrower has several pending loans at the same time. The term is mostly used when borrowers apply for and acquire multiple small loans approved within a short time gap, with each of the loans having similar interest rates and repayment terms. You are not taking out one loan to finance another one, but you have several loans at once, so you are actually stacking them.
How Loan Stacking Happens
At times, taking out a second loan while having another may be against the first lender’s terms. So, why don’t the subsequent lenders find out if a borrower already has outstanding loans? Well, although a lender can see from your credit report that you have taken out a loan with another lender, it may take up to 30 days for new credits and inquiries to reflect this in the credit report. As such, a borrower can get several loans without any of the lenders finding out about it.
Risks of Loan Stacking
Isn’t loan stacking permissible if you are able to pay the loans on time and in full as per your contract with the lenders? Absolutely not. It may seem safe and harmless at first glance, but it carries two major risks:
Having several loans at the same time puts extra pressure on the cash flow of your business:
When lenders are deciding to approve and give you a loan, they rely on your cash flow information, among other things. When you stack loans, it means that several lenders are relying on the same set of information to give you a loan, but without the knowledge that you have another pending loan. With several lenders relying on the same pool of cash for you to repay their loans, your business resources are overstretched.
At some point, it may become unsustainable and the business may start considering taking out other loans to service the earlier ones, thereby ending up in a negative debt cycle. The borrower is also likely to default on all the loans and accordingly close shop, as well as damage their credit score. A good credit score is vital for seeking credit and for other benefits. If your score is poor, you can engage experts to help boost your score.
Having several loans could go against the terms of your first loan, leading to an automatic default on the first one:
Many lenders prohibit borrowers from taking out additional loans when the loan with them is not yet paid off. If the lender prohibits stacking and you go ahead and do it anyway, you will have violated that clause in the contract, which could automatically send you into default. This can trigger litigation’s against you or your business, and if you are unable to pay the loan, your assets could be liquidated, or you could be compelled to pay the full amount immediately, which will also decrease your credit score.
Alternatives to Loan Stacking
While you or your business may need more funds after getting a loan, stacking loans is not a wise option.
Here are some alternatives:
Approach Your Initial Lender and Request More Funds
Most lenders will give their borrowers more funds if they have paid about half of their first loan or if they have been consistent with their payments over a reasonable period.
Refinance Your Loan
Having been making timely payments on your loan, you can approach another lender for a bigger loan. Your second lender will pay off the original, thus leaving you with one loan to repay with one interest rate.
Loan stacking may seem like a reasonable way to raise finances, but its risks outweigh the benefits. In addition to the earlier discussed risks, you may ruin your relationship with your lenders, thereby jeopardizing your future chances of getting credit. Thus, avoid stacking loans at all costs, as this quick fix is not worth the long term pain.