By Carla Ulloa:
Most merchant cash advances are personal and not business loans. Merchant accounts also don’t do their diligence like a traditional lender. Plus they charge a very high APR that is almost impossible to get out of unless you refinance or repay the money in a short period of time. For example, LoanMe is an unsecured online installment lender with a 94% interest rate. Their terms are unfavorable and can cause more harm than good.
Lenders are facing a challenge with some of the federal guidelines of the California State Loan Guarantee Program when it comes to refinancing debt from merchant cash advance accounts and some online financing companies. No one wants to encourage poor financing decisions by refinancing high interest rates, but in most cases, if companies don’t refinance, they will end up with cash flow problems and could go out of business.
For example, one of our potential borrowers owns an existing business in Los Angeles County that has two cash advance notes and an alternative California licensed lender’s note. Our borrower felt that the cash advances were his only option since the licensed lender did not provide him enough financing to move his business forward. The borrower used the cash advance money for marketing to increase his sales, which he did, as is evident by his increase of gross income in 2015. He is seeking a $50,000 loan for working capital and debt refinance of the three notes.
As a credit enhancement, CDC requested the State to guarantee each loan up to 80%. The State guidelines do not allow for a guarantee of debt that refinances merchant cash advance loans and online lender loans. In order to qualify for a debt refinance under the State Guarantee program, the following must be met:
- The loan must cannot be made to an individual unless it is a DBA;
- The borrower must provide proof on how the proceeds were used;
- The lender/merchant must have a California lender license or be a regulated lender;
- The refinance must improve cash flow by 10%;
- The borrower must provide a personal guarantee and pledge any/all available collateral (either personal or business);
- All debts must be current; and
- The cash advance/lender needs to be approved by the State as a participatory lender in the State Loan Guarantee program. In other words, the original lender must have been an approved and qualified lender in the loan guarantee program when they made the original cash advance or loan.
How do we resolve this issue?
The State is looking into the feasibility of changing their rules for loan guarantees. Until that happens, I have proposed to issue two separate loans to the borrower.
The first loan will be used to refinance the alternative California licensed lender’s note (not a merchant account) and provide working capital since this use of proceeds will qualify under the State Loan Guarantee program.
The second loan will be used to refinance the two merchant cash advances, however CDC will take 100% of the risk; the State cannot guarantee the non-eligible loan and the borrower does not have any personal/business collateral.
The borrower’s monthly payments will reduce from approximately $4,000 to $1,200, which is a much more sustainable debt load. The CDC loans will make such an impact to this borrower’s business and success.
While separating loans and increasing our risk exposure is a short term solution for this borrower, doing so is not part of our long term lending strategy. The solution is for the State to guarantee loans such as the example provided above.