Taking out a business loan to cover the costs of an existing loan, or to add to the amount of capital you can borrow, may sound like a relatively simple proposition at first. You’re simply doing what many consumers do when it comes to their credit cards and other bills – shifting a financial issue in a different direction in order to solve an immediate problem. However, the consequences are more significant than you might expect at first. You’re indebted to multiple organizations, responsible for multiple interest payments (possibly at different rates) and, without necessarily knowing it, you may be increasing the risk of overall default for the alternative lenders that have offered you the option to “stack” one loan atop another. However, loan stacking has become a strangely de rigueur element of the alternative lending conversation.
Where loan stacking was once an unwritten no-go for most lenders, there are now financial providers whose main source of revenue comes from arranging stacked loans for small business borrowers – a troubling trend, and one that rides on the back of heavily automated and algorithmically processed loan underwriting. The market for stacking loans is by no means bare of interest, as maximizing cash flow at minimal borrowing cost rates continually among the most pressing concerns for business owners. In our view, there is much more to be gained from underwriting a loan that works for the small business customer in the long term than in stacking the deck, as it were, against their profitability.
Some analysts have called stacking a “blind spot” for the alternative lending industry, in the sense that multiple algorithm-driven lenders might be likely to approve and lend money to the same prospective borrowers without considering each other. This increases risk overall, as the percentage of the borrower’s revenue tied up in repayments goes up and their ability to fulfill their financial obligations decreases. Loan stacking is also potentially more harmful to cash flow than it appears to the business borrower. Though the amount of cash available increases in a stacked loan, the repayment increases to a point that invalidates all the other advantages of a merchant advance or alternative financing product, such as repayment flexibility, scalability, and scalable growth provisions for businesses.
Finally, stacking presents a risk to investors in the alternative financing space. Marketplace lenders need to slow their lending processes and improve sharing of credit information in order to maintain investor confidence. The importance of human-centric and customer-centric lending must outweigh the speed and convenience of fully automated approval processes which cause investor capital to become tied into loans that are potentially less secure. It’s a precarious situation to be sure – for the lenders, the investors, and the customers all in the same breath.