During the 2008 recession, big banks and credit unions became wary of lending money to small businesses, making it hard for them to secure working capital to fund their operations. As a result, many small business owners resorted to loan stacking, a strategy that involves taking two or more loans from one or multiple lenders.
While this may seem like a great idea, taking on more than what you can handle can quickly put you in a cycle of debt that’s difficult to come out of. Understanding loan stacking, its risks, and other alternatives is important before you start saying “yes” to multiple loans at the same time.
Key Takeaways
- Loan stacking refers to taking out two or more loans simultaneously. While it may seem like a great way to reach a financial goal, there are risks associated with it.
- Many lenders do not allow loan stacking because they don’t want to compete with other lenders over collateral in case you can’t repay your loans.
- Loan stacking can also put you in a cycle of debt that’s difficult to get out of. Some lenders ask for daily or weekly payments, which can be bad for your cash flow.
- Alternatives to loan stacking include reducing expenses, requesting additional funds from your current lender, applying for complimentary loan products, and refinancing your debt.
What is Loan Stacking and How Does It Work?
Loan stacking occurs when a borrower takes multiple loans from different lenders at the same time to meet a financial goal.
Here’s a sample scenario: You’re planning to expand your store, but are short on funds. You did your math and found that you’ll need $30,000 to complete the project, so you find a lender and apply for a small business loan, but only get approved for $15,000.
To get the other $15,000, you find an online lender and apply for a second loan. The second lender approves you for $7000, so you see a third lender that approves you for $8,000.
What are the Risks Involved in Loan Stacking?
Financial institutions and advisors discourage small business owners from stacking loans because of:
(1) It adds more pressure to your business’s cash flow
(2) You may enter into a negative cycle of debt that’s difficult to escape
(3) Many lenders have an anti-stacking policy
Added Pressure to Your Cash Flow
Stacking loans can be a quick fix solution for small business owners looking to address cash flow issues. Nevertheless, it’s also important to consider the repercussions of taking out additional loans.
When these business owners use stacked loans to address their cash flow problems, it increases their debt level while adding pressure to repay multiple creditors. Aside from increasing your risk of defaulting due to having too many loan payments at once, it can also make it harder for you to stay on top of your payments.
You May Enter a Negative Cycle of Debt
Studies show that small business owners spend more than a fourth of their cash flow on settling debt. Instead of the usual monthly payments, some lenders ask for daily or weekly installments with high interest rates, which worsen cash flow issues. Business owners are pushed to take out loans, resulting in multiple loan payments actively due, making it easier to be in a negative cycle of debt.
If you’re unable to repay the loan, it could also lead to default. Lenders could repossess your personal and business assets, your credit score will take a hit, and you may be asked to repay the full amount.
Many Lenders Have an Anti-Stacking Policy
Some lenders do not allow loan stacking, even if you can demonstrate that you can easily repay multiple loans. Your agreement with your primary lender should outline whether you can apply for additional loans before your loan with them is repaid. For some, violating your loan agreement would automatically mean a default.
Let’s say you secured a loan from an alternative lender. They usually request a personal guarantee and file a blanket lien on your business assets. This means the lender has the right to repossess and sell your assets to repay your debt. Prohibited loan stacking means you’re interfering with your lender’s lien, so you automatically default on your loan.
Lenders don’t like it when you take more than one loan at a given time because they don’t want to compete over collateral if you default. If you have multiple loans that you can’t repay, Lender #1 might seize the collateral that Lender #2 also wanted to get to cover the default, leaving less money for the second lender. Lenders always make sure they can collect their loans no matter what. This is why many alternative lenders prohibit loan stacking in their agreements.
Note: The rules regarding loan stacking vary from lender to lender. Contact your lending company or review your initial loan agreement to check if they allow loan stacking. Aside from automatically defaulting on the loan, violating your agreement may expose you to several legal proceedings against you and your business.
What are the Alternatives to Loan Stacking?
With the potential risks involved, stacking loans may not be the best way to reach your financial goals. Here are some of the alternatives you can check out:
Reduce Your Expenses
If you plan to stack loans to keep up with the bills, consider reducing your expenses. Evaluate your business and see if you can do the following:
- Negotiate better terms with your suppliers or reduce your orders.
- Barter your services to your vendors for free in exchange for materials or supplies.
- Explore remote work options for yourself and your employees, if feasible.
- Move to a less expensive location.
- Eliminate any contracts or maintenance plans you don’t necessarily need.
- Cut back on your office or store’s utility bills.
Reevaluate your priorities and check if there are areas you can cut back on both short- and long-term expenses.
Ask Your Current Lender for Additional Funding
If you’ve already established a relationship with your current lender, they might approve you for additional funding under the right circumstances. Some lenders allow business owners to receive more money if they’ve repaid at least 50% of their initial loan and/or made timely payments. However, you need to demonstrate why you should be approved for more capital, like an increase in business revenues or a good personal credit report.
When you request additional business funding, lenders check your debt service coverage ratio (DSCR), which measures your capacity to cover debt payments. To get your DSCR, divide your business’s annual net income by interest and yearly loan payments. You should get at least 1.2 after adding the additional funding. If this isn’t the case, you’ll need to return when your income increases.
Remember that if you’ve been late with payments on your existing loan, you may not be able to get additional funds.
Refinance Your Debt
Debt refinancing is getting another loan with better terms to pay off existing debt. Ideally, the second loan has lower interest rates, better repayment terms, and other cost-cutting terms that could further reduce your debt. Debt refinancing loan products are available through banks, credit unions, and alternative lenders.
You can also refinance debt using SBA loans like 7(a) and Express loans. The Small Business Administration guarantees a portion of the debt refinancing loan through SBA-accredited banks and lenders. However, they will not guarantee to refinance the existing loan you’re trying to pay off.
Apply for Complementary Loans
Loan stacking is risky when you borrow money from multiple lenders with similar terms and rates, or when different lenders have a lien on the same asset. However, there are business loans that can coexist healthily, just like when a consumer has a car loan and a student loan at the same time.
It works because borrowers often use the loan for different purposes, and the collateral used differs for each loan product.
Here’s an example: Suppose you own a construction business and have applied for a business line of credit from an online lender and an equipment loan from another lender. You’ll likely use the line of credit to fund emergency expenses or day-to-day operations and repay the loan before you go over the limit. The line of credit lender also placed a lien on your personal assets.
The equipment loan is used to buy heavy equipment needed for your construction company, and you repay it with fixed monthly installments over five years. The heavy equipment is the collateral for the loan, so the lender can seize your assets in case you default, while the line of credit lender has the right to your personal assets.
Here are some examples of complementary financing products:
- Business line of credit + a loan
- Equipment financing + loan or line of credit
- SBA loan + short-term loan
- Invoice financing + a loan
How to Protect Yourself from the Risks of Loan Stacking
There are two ways loan stacking can happen: borrower-initiated and lender-initiated.
Borrower-Initiated Loan Stacking
In this type of loan stacking, the borrower seeks out and applies for another loan. This is easy to avoid because you only have to refrain from getting another loan.
Lender-Initiated Loan Stacking
Lender-initiated loan stacking is where a lender reaches out to you and offers you a new loan. Beware of these predatory lenders because their strategy is to look through public records to see which businesses recently took out financing. They will try to contact these businesses and sell business loans with poor terms that will eventually affect your personal and business credit scores.
Protect yourself from these unscrupulous lenders by researching any lender-initiated offer. Ask questions, check online reviews, review the loan terms they’re offering, and more. You can also talk to a financial expert who can help you understand the fine print to avoid committing loan stacking fraud and agreements that can hurt your business’s long-term health.
The Bottom Line
Loan stacking may seem like a quick fix when you need cash, but it often leads to more debt and financial strain—a trap many business owners regret.
Instead of risking financial stress and instability, explore smarter alternatives like refinancing, expense reduction, or complementary loan products to avoid loan stacking altogether.
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