With the increase in lending options from alternative financing providers, more SMEs are taking out multiple loans from different lenders at the same time. Known as loan stacking, this increases the risk of defaults as borrowers worsen their repayment ability and lenders being unable to recover their loans.

Loan stacking has emerged as a problem within the alternative financing industry. As most online lenders function as a bridge between investors willing to lend to riskier SMEs in return for higher yield, lenders often employ less rigorous credit assessments and underwriting standards than banks.

Loan stacking is different from refinancing, whereby the borrower takes up a new loan to repay existing loans. Businesses involved in loan stacking would find themselves using a significant portion of cash flow to repay their loans, which is obviously unsustainable. The borrower would end up in a vicious cycle of debt repayment, involving high interest rates and short repayment timelines. When the well runs dry, bankruptcy is imminent.

Even if loan stacking does not cause the business to default, there are still risks. If the business owner is the personal guarantor for the loan, loan stacking will have negative impact on his/her individual credit bureau score (CBS). Most loan applications begin with lenders checking guarantors’ credit bureau report, which will inevitably reduce the chances for borrowers to qualify for cheaper bank financing due to poor CBS at a glance. It may seem easy filling out a loan application, but it is also as easy to reject an application, resulting in more minus points on your CBS.

Now you know loan stacking is bad, but what are the alternatives?

Loan consolidation and increase in credit limit

There are more viable alternatives to loan stacking, such as debt consolidation or simply requesting for an increase in credit limit from the existing lender. Although the business might still be taking on more debt, there would only be a single monthly payment instead of several payments to make. As a result, financing costs would reduce significantly.

Matching products to your problems or needs

In addition, it is common for banks and online lenders to have a wider reach for term loans, as more sales staff are recruited into this space, and this may include loan brokers with limited product coverage. What does this mean for businesses? Businesses are offered a single solution – term loan -, which is not always the solution for their problems or needs. Small business owners, in this case, are especially vulnerable due to the unfortunate fact that they have limited knowledge of financing with no in-house financial officer to seek advice from, and would take what is given to them in difficult times. Little do they know that there are more suitable solutions such as invoice financing, hire purchase financing and bank trade facilities, just to name a few.

If a business has a trade gap between 30-120 days, products such as invoice financing, factoring and trade facilities specifically fill in this gap. Using a term loan to address the trade gap issue is a total product mismatch. Likewise, a business may need to purchase equipment or machinery and hire purchase loans would fit right into the picture, but definitely not with a term loan.

We cannot stress enough the need to seek out a trusted advisor and conduct thorough credit and financial assessment, before deciding on the most suitable financing solution for the business. Financing may seem as easy as shopping for clothes, but there is no one-size-fits-all solution; utilise only what works best for your company.