Dangers of Cash Advance Loans

Cash Advance Dangers

October 2018

A merchant cash advance was originally structured as a lump-sum payment to a business in exchange for an agreed-upon percentage of future credit card and / or debit card sales. These “merchant cash advance companies” are not loans-rather a sale of a portion of future credit and/or debit card sales. Therefore, merchant cash advance companies claim that they are not bound by state usury laws that limit lenders from charting high-interest rates. This technically allows them to operate in a largely unregulated market and charge much higher interest rates than banks.

The Dangers of Cash Advance Loans Cash advance loans, also known as merchant cash advances, are the product that birthed the online lending industry. A solution for business owners that needed cash but weren’t able to get approved by the bank, MCAs provided business owners with cash, which would be paid back (along with fees), from a set percent of their daily credit card sales. For businesses who were used to being told “No” when they needed financing, MCAs were revolutionary. However, it wasn’t long before lenders saw the hesitancy from businesses to change their payment processors (which many MCA companies require). Not to mention, the direct pull from daily sales was discouraging for these hard-working entrepreneurs. They’d slave for hours to make those sales to then see a significant portion of them gobbled up every day. With time, this led to the development of the short-term loan product, term loans 3 to 18 months in length, repaid daily through ACH debits out of a business bank account. While it still hits the business owner every business day, not having to change payment processors and pulling a percentage of daily sales made the product easier to sell. What we’ve seen take course as the two products continue to differentiate themselves is that short-term loans have also become less expensive than MCAs.

Together, MCAs and short-term loans make up a good portion, if not majority of the loans available online. But they can be very dangerous products if not approached wisely and used properly. Here are 3 things to watch out for when it comes to these shorter-term loan products:

Is it right for your business model? With MCAs, you’re paying back a set percent of your daily sales. So while you do pay back more when business is better and less when business slows, if you don’t receive a ton of daily transactions, it’s going to take forever to pay the advance off. Similarly, with short-term loans, you’re getting debited every business day. If you don’t have money coming into your bank account frequently, then there’s a chance these withdrawals could leave your bank account at $0, if not negative. Cash advance and short-term products tend to work better for businesses that have daily transactions, such a restaurants or salons. If you only receive a few big payments a month from customers, you should have a conversation with your accountant, financial advisor, or lender to see if this product will actually work for you. Or better yet, avoid it altogether. I understand sometimes it might be all that you’ve qualified for, but you don’t want to find yourself paying hefty overdraft fees regularly and putting your business in a compromising position.

Is it all you can qualify for? Another obstacle facing business owners during their financing search is loan brokers. While there are some loan brokers out there looking out for the best interest of small businesses, there are all-too-many who are looking out only for themselves. Loan brokers are notorious for calling business owners daily, telling them they can get them financing—fast! You probably ignore them now, but what happens when you need quick cash to get a project off the ground? It’s all too tempting to say “Let’s do it” to the person on the other end of the line. More times than not, these brokers are pushing cash advance and shorter-term products, as they’re where the broker makes the most money. But this doesn’t necessarily mean it’s the only product you can qualify for. I can’t tell you how many times we have businesses come to us to refinance shorter-term debt when they could have qualified for a longer-term and less expensive loan in the first place. Not taking the time to shop and see if you do have a lower-cost option out there could cost you thousands in the end.

What are you using the money for? I’ve said it a few times already, but it’s important to emphasize: cash advance loans are extremely expensive. And while shorter-term loans can be more affordable, they themselves can also be shockingly pricey. That’s why you need to think twice before taking on this type of debt. If you are looking for financing for a revenue-generating opportunity, this makes a lot more sense, assuming you’ll be making more off the opportunity than the cost of the financing. But if you’re looking because you’re in a cash crunch, tread carefully. While this may be all you can qualify for, do you have a clear plan for how you’ll pay it back? It might be best to explore other ways to get your business back on better financial footing. If you’re evaluating a cash advance option or even a shorter-term loan, keep these things in mind. Always start your financing search early, so you’re not backed into a loan product for the sake of time. Shop around, think thoughtfully about how it will be repaid, and make sure the payment structure makes sense for your own business model. Your business, and your bank account, will be better for it in the end.