High-Risk Business Loans: What You Need To Know
When you’ve built a business from the ground up, you’d probably do just about anything to keep it afloat. Your options, however, might be limited if your financial history is flawed, leaving you with some tough decisions.
In the face of a cash crunch, a high-risk business loan might seem like a solid solution. These short-term loans provide capital to business owners who have poor credit, cash flow problems or other financial issues — and who might otherwise run into trouble applying for a bank loan.
These loans, however, are risky for both the lender and borrower. You could find yourself in over your head with high interest rates and fast repayment terms, which could lead to more trouble. If you’re still considering a high-risk business loan, here’s what you need to know before you take on more than you can handle.
What is a high-risk loan?
High-risk loans are typically short-term loans with high interest rates, Brian L. Thompson, president of the National Society of Accountants, said. Terms are generally shorter than six months — and sometimes as few as 90 days, he said. Though not technically a loan, a merchant cash advance is also considered a high-risk financing option.
Nonbank alternative lenders issue these loans to high-risk borrowers, typically approving smaller loan amounts. The less likely you are to repay your loan, the riskier you become as a borrower. Lenders base their rates on your creditworthiness and other financial aspects of your business. An interest rate of 76 percent is among the highest Thompson has seen for a high-risk loan.
Lenders also consider some industries to be high-risk. These industries often include oil and gas, construction or moving companies. In addition, lenders often consider sole proprietorships as high-risk. Lenders might deem san industry risky because of volatility or high failure rates within the field.
High-risk business loans are designed for borrowers who can’t get loans under normal circumstances, Thompson said. If you have problems with your credit or cash flow, you might not qualify for a standard business loan, and a high-risk loan could be your only option for covering business expenses.
“The only rationale to go with these high-risk loans is you have no other possible financing options,” Thompson said. “You’re at your last straw.”
Differences between high-risk and standard loans
Compared to standard business loans, high-risk loans have higher rates and faster repayment terms. Traditional banks offer short-term business loans, but interest rates are not nearly as high, and payments are not as frequent as they would be with high-risk loans, Thompson said.
Instead of making monthly payments toward your debt like you would with a standard business loan, you make daily or weekly payments toward your high-risk loan, Thompson said. High-risk loan companies want to maintain as much control as possible. They might take a portion of your daily credit card sales as repayment or make regular withdrawals from your bank account — both common practices among merchant cash advance providers as well — because they don’t trust you to make payments. The short terms reduce the amount of time the lender is at risk, Thompson said.
With standard small business loans, you could offer collateral to secure the loan and reduce your interest rate. But collateral wouldn’t affect a high-risk loan, Thompson said, because it’s an unsecured financing product. Business owners who turn to high-risk loans often can’t offer collateral to secure a loan anyway.
“If you have to go to a high-risk loan, you’ve already financed your assets,” Thompson said. “You already explored that option.”
Business owners could find high-risk loans from nonbank alternatives lenders, many of which operate online. These lenders don’t require business owners to meet the same credit, cash flow or business documentation requirements that they would face when applying for traditional financing. Alternative lenders typically offer preapproval in minutes and funding within a week.
The pros and cons of high-risk business loans
- Financing for all. High-risk loans are designed for business owners who cannot get a standard loan but still need capital to cover expenses. Business owners with troublesome financials or those with no financial histories can count on being approved for a high-risk loan to cover expenses like payroll or inventory.
- No collateral. Although not being able to offer collateral to reduce your interest rate isn’t ideal, at least you don’t have to worry about the lender seizing any assets if you fail to make payments.
- Quick application process. Because the lender doesn’t have to evaluate collateral, the approval process for a high-risk loan is quick. The process is streamlined to ensure you receive the funds as fast as possible.
- Disturbs cash flow. Daily or weekly repayments can cause you to reallocate a portion of your cash flow each day, detracting from the cash you would use to cover day-to-day expenses. Thompson often sees business owners struggling to keep their cash flows positive after taking on a high-risk loan.
- Smaller loan amounts. High-risk business loans come in smaller amounts than standard loans because lenders are usually unwilling to loan large amounts of money to risky borrowers. For example, you likely couldn’t use this type of loan to fully cover any major projects or expenses.
- Expensive product. Lenders typically charge high interest rates on high-risk loans to ensure they can recoup losses if you default. That means you pay a high price for a small loan amount.
When to consider a high-risk loan
Business owners typically turn to high-risk loans when they are in dire need of capital. Taking out one of these loans suggests your business isn’t completely stable. “A lot of times that’s an indicator that the company is on its last leg,” Thompson said.
However, high-risk loan companies can provide struggling businesses with the cash they need to keep the doors open. “There can still be financing regardless of the financial situation that you’re in,” Thompson said.
Brand-new businesses might turn to high-risk business loans as well. A traditional bank — or the U.S. Small Business Administration — won’t likely approve new business owners without any financial history, he said. Although you must repay your debt quickly, a high-risk loan could help you get your business off the ground if you have no other option.
“But at the end of the day, you’re going to pay for that,” Thompson said.
What to look for in a lender
The qualities you should look for when shopping for a high-risk business loan are the same for any business-related transaction, Thompson said. Spending some time researching the company can give you an idea of its trustworthiness. Here’s what to look for:
- Website design and security. You should consider the appearance of the company’s website and how professional it looks. A reputable lender should have its leadership and management team listed on its site. If the website has tools that enable you to apply for a loan, make payments and check your balance, the company should have protective systems in place. Check if the website has a security certificate and a valid URL address before you share any sensitive data.
- Availability of information. Some lenders do not make their terms and fees available online, which might be a red flag. Before you proceed with a lender, make sure you have a clear picture of your total repayment amount as well as how often you would be making payments. Check for hidden fees that could increase the cost of your loan, such as an origination fee, application fee, closing fee or a prepayment penalty.
- Loan requirements. High-risk loan companies have fewer eligibility requirements than traditional lenders, but be wary of a company with no requirements. A reputable lender should at least require a minimum credit score and ask for your financial statements or projections. A lender that doesn’t ask for any information will likely charge a higher interest rate than lenders that do have eligibility standards.
- Customer service. When you speak to a loan company’s customer service representative, he or she should be professional and courteous — and help you get the information you need. If a lender doesn’t share much information online regarding fees and terms, you likely have to get in touch with the customer service department to get those details.
- Company reputation. Before deciding on a lender, search online for any negative comments about the company. You can also check the Better Business Bureau or your local Chamber of Commerce to see if there are any complaints against the company or other issues on record.
Alternatives to high-risk loans
If you need capital quickly but don’t want to face excessive interest rates, consider these alternatives to high-risk business loans:
Business credit cards.
Business credit cards offer short-term financing, allowing you to draw from a preapproved credit limit and repay debts within 30 days. Although a business credit card could have high interest rates, Thompson said, it would be a better option than a high-risk loan.
An equipment loan enables you to offer a piece of equipment as collateral to secure the loan, reducing the amount of interest you have to pay. If you need financing to pay for equipment that immediately, an equipment loan would save you from the cost of high-risk financing.
Learn more about equipment financing.
Also called factoring, invoice financing lets business owners sell their outstanding invoices in exchange for cash. The lender then collects on the invoices for a single repayment. Invoice financing might involve fees, but you would quickly receive cash in hand.
Learn more about invoice financing.
Friends and family members.
Family members and friends might loan you money if you can demonstrate your abilities as a business owner, Thompson said. You might have to pay interest, but it would likely be less than what you would pay for a high-risk loan, he said. Friends and family members with good credit could also act as a cosigner to help you get a traditional loan. If they take on the risk, a traditional lender might be more willing to approve your loan.
To increase your chances of being approved for a standard business loan, you should work on building a relationship with your bank, Thompson said. Establishing your reputation as a dependable business owner will help you secure financing when you’re in a pinch, even if your credit is less than perfect, he said.
“If you have a relationship with a loan originator, you’re in a better position to get a loan,” Thompson said. “Outside of that, no one is going to bat for you.”
The bottom line
If you urgently need an infusion of capital to keep your business open, you might be able to find relief through a high-risk business loan. But be careful to not take on more debt than you can repay.
High-risk loans have short terms and high interest rates, meaning you have to pay back a large sum of money quickly. High-risk loans typically require daily or weekly repayments, which could impact your cash flow and working capital. If you take out a merchant cash advance, which is not a loan but still considered high risk, the cash advance provider takes a portion of your daily credit card transactions or other receivables as repayment.
Before choosing a high-risk business loan, be sure to consider all the alternatives. If you feel a high-risk loan is the best option for your business, understand all the terms and conditions of your loan before making the commitment.
“The end has got to justify the means,” Thompson said.