It’s understandable that lenders want you to pay a premium for the credit risk that comes with lending you money. For all of the borrowers that fail to make repayments, they need to make up for successfully repaid loans – plus some profit.
However, it’s difficult to justify the interest rate that is applied to some of the bad credit business loans out there. Bad credit loans are, of course, designed for those with a poor history of repayments, but the APR that is sometimes applied is in the hundreds or even thousands. Like those so called “guaranteed approval business loans”: some are fair, whilst most have incredibly high interest rates.
These share similarities to payday loan companies for personal loans. Not only in the extortionate APR, but also in its use case, which is often designed for emergencies to meet other short-term liabilities, like rent and other debts.
Of course, in emergencies, people and businesses sometimes act irrationally or do not have time to think through the long-term impacts of their decisions, which can land them into a debt trap. A debt trap is essentially where the business or individual is borrowing more money to pay for last month’s debt repayments. Because of the interest involved, the debt only seems to grow, and it becomes increasingly difficult to buy (and by buy, I mean borrow) your way out of trouble.
Because a business loan has less stigma attached to it than a payday personal loan, we can often divide them into two separate things in our minds. We may consider the predatory behaviour of a high APR personal loan to be avoided at all costs, but a business loan seems more justifiable because it’s for our business needs.
In reality, a business loan may be almost identical to a personal loan, so categorising them differently in your mind is just a dangerous illusion. If your business is not incorporated (not a limited company), for example you’re a sole trader, then this means that your business has unlimited liability. Business owners are legally responsible for any debt that the business accrues, which isn’t much different from a personal loan.
In both circumstances, our personal assets are vulnerable to being repossessed in the event of failing to repay the debt. Of course, there are unsecured loans (as many personal loans are), though failing to pay will still bring the costly punishment of a depleted credit score. This will make all future debts even more expensive, whether they’re business or personal loans.
This is a totally different story when your business is incorporated, which can protect your personal assets when using a secured loan. However, it’s more difficult to gain approval for healthy secured business loans as an incorporated company, and they will also require substantial business assets to be put forward which many firms do not have.
Just because your loan is unsecured, it doesn’t mean that you couldn’t find it in a situation where debt collectors are knocking on your door looking to strike a deal. It also doesn’t mean that an unsecured loan cannot turn into a secured loan, whether it’s for business or personal use.
One way this can happen is if the lender applies to the court to obtain a county court judgement due to a failure to repay. If they succeed in the CCJ, then they can apply for a charging order, which is something that can be registered as a secured debt on your property. Very quickly, your own house could be in jeopardy on a loan you thought was totally unsecured.
Another consequence of not making repayments is that you will most likely be charged late fees, which add the debt up to a larger amount. If payments are set up to be automatically deducted from your account, like many business loans are, then you could find yourself overdrawn with your bank – again, incurring fees. In fact, because it’s a business loan, the fees may be even higher, as (depending on what country you’re in) the business loans are less likely to be covered under consumer protection laws.
Finally, defaulting on a loan will most likely result in the lender selling your loan to another party – the debt collectors.
Having your debt change into the hands of debt collectors can be a true nightmare. Every day, relentless phone calls attempt to get hold of you. If you pick up, they are known to often be threatening and intimidating. In conjunction with this, you will likely be receiving endless timber through your letterbox asking for money. This can take a serious toll on one’s mental health, particularly if they’re not educated on where they stand or the consequences of ignoring the debt collector – imagination can run wild.
If the debt collectors do not get what they want, the loan will usually be given to a debt collection law firm that will be representing the original creditor or the recent debt collector. This is where you may receive attempts of communication striving to strike a settlement deal, or, receiving a letter stating a lawsuit has been filed against you.
The moral of the story here is to no longer separate business loans and personal loans in our minds, particularly when we are self-employed or a sole trader (unincorporated). Despite a few small differences, the predatory behaviour of both types of lenders are the same, the high APR can be the same (and therefore equally as destructive), and our personal liability remains the same.
The biggest challenge is that we still must recognise that debt is necessary in the growth of most businesses. In fact, a company with too low gearing can raise red flags for investors. However, gearing a company is not only more applicable to larger, incorporated companies, but it’s also not a sign to take on high-interest debt. Most companies using debt to grow their companies are using under 7% APR business bank loans.
For anyone looking to take out higher APR business loans to tie over cash flow issues, it’s best to be avoided. In a few small circumstances, it may be worth it if you’re guaranteed and totally sure the repayments can be made in a short time frame. Any misjudgements in your ability to repay could cost you greatly.
Furthermore, it’s vitally important to never take out a loan when trying to save a failing business. The fallacy of sunk costs can often mean we try to dig ourselves out of a failing business because we have invested so much into it. But, past investment and money lost is in the past, and we should not lose any more money by building up debt when it’s unlikely that it will turn the business around.