The Inevitable Slow Death of the Low Interest Rate Loan and Rise of the Merchant Cash Advance

"Once the recession clears up, then things will be back to normal," is a phrase too often spoken these days. As the economy continues to sputter, small businesses have been patiently waiting for the banks to reopen their coffers. The restaurants, salons, and retail stores that used lines of credit in the past to finance operations and expand are sitting tight.

An in depth analysis revealed that funding for small businesses is still easily available but through alternative sources. For long time business owners, it's hard to think of going to any place but the bank down the street. If a loan for $50,000 was obtained at 4% APR in 2004, chances are an offer for the same loan 2 years later but at 8% APR could be perceived as an outrageous increase. The cold reality is that the bank is going to lose money either way.

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A very simple example would be a $50,000 loan at 5% non-compounding interest over 1 year, payable in full at the end. That would amount to $2,500 profit for the bank. There are of course bank administrative costs that eat into that such as employee salaries, overhead costs, rent, legal fees, etc. Suddenly the profit to be gained on this loan is much lower.

There are two other downsides. One is the opportunity cost of not having that cash on hand. Perhaps that could've been used in a much more short term investment with a higher yield. It also could've been used to preserve liquidity and prevent their own cash flow issues. The other downside is the risk of default. There is always the risk that a business will not be able to pay it on time or pay it back at all.

The FICO credit scoring model is a tool that helps banks predict the risk of default. Examining cash flow history, financial statements, sales projections, and confirming compliance with regulations also helps to filter out the best candidates. Ultimately there will be defaults regardless.

But if a small business owner thought the bank was making a pretty penny off their loan at 4% and milking them dry at 8%, it's time for a reality check. In 2009, the Small Business Administration (SBA) introduced the America's Recovery Capital loan (ARC) to stimulate lending. The ARC loan is a $35,000, interest-free, 12 month deferred payment loan that is fully guaranteed by the SBA. $256 Million was allocated to the program. It is a fantastic opportunity for a business owner and a terrible burden for both the bank and tax payer. The SBA predicted an astounding 56 percent default rate on the funds. Yes, 56%.

Keep in mind that these loans still had to go through an arduous underwriting process. Even then, more than half will end up in default. That being said, the bank would be losing money even if these loans were being originated at 50% interest.

The SBA offered another incentive for banks to lend in the Economic Stimulus Bill. The guarantee on 7(a) loan defaults increased from 75 percent to 90 percent. Fees were waived or reduced. The incentive expired in May, 2010 and since then banks have issued a significantly lower amount of these loans. The main factor being the lower default coverage.

It should be considered ridiculous that banks are so less willing to lend with only a 75 percent default guarantee. Imagine if there was no SBA and there was a 0% percent guarantee. Without the tax payer's money being available at the leisure of the government to reimburse banks for what is a hopeless cycle of losses, low interest rates in small business lending can not and should not exist.

What is happening now is an economic realization of this catastrophe. In the meantime, there are alternatives for small business owners out there. Should your bank never offer you that 4% or 8% APR loan again, it's time to look into Venture Capital or a Merchant Cash Advance.

In this recession, if anything is to be learned, it's to readjust expectations and look into options that wouldn't have been considered previously. For those that have stigmatized funding programs like the Merchant Cash Advance it should be stated that they are by no means a loan for the desperate.

A Merchant Cash Advance is a program designed to repay the funding company by allowing them to withhold a percentage of each credit card sale that is conducted up until the amount taken plus a fee is reached. Some nay-sayers are quick to point out that the costs are more expensive than a loan, in some cases a lot more.

In a country where everyone has grown up with interest rates below 10%, it comes as no surprise that the approval terms on a Merchant Cash Advance could inflict damage on a business owner's pride and expectations. It's time for America to get over it. Readjust or get left in the dust!

If $10,000 is obtained through a Merchant Cash Advance and spent on advertising that directly or indirectly leads to $20,000 in revenue, then repaying the funding provider $13,000 was a money making decision. If the only oven in a restaurant's kitchen breaks, would it be practical to fix it and pay more than you expect or would you rather close the restaurant because the oven doesn't work?

The business owners taking advantage of Merchant Cash Advances are a step ahead of those that haven't. The competing retail store across the street from yours bought a full yellow page ad, a new neon sign, a Google ad campaign, and fresh exterior wall paint with their Merchant Cash Advance. How will you fare against the revamped and revived competitor? Perhaps they paid a pretty penny. If you hold out for that 4% loan to come back, it will be too late.

Merchant Cash Advances are not for the desperate. While the process is usually quick, there is rigid underwriting criteria. Ignore the marketing phrases of 90% approval rates. That makes them sound overly attainable. It isn't THAT easy. Tax liens, judgments, poor credit, and missed home mortgage payments can all inhibit your chances of approval depending on the funding provider. You will need to provide merchant processing statements, bank statements, business licenses, and contact information for your business property landlord. Extensive cash flow analysis is conducted by teams of experts. Some providers even require a list of creditors and trade references.

Merchant Cash Advances are today's sustainable funding source. There is no reliance on government guarantees and deficit increasing stimulus programs. Merchant Cash Advance providers such as Sure Payment Solutions in New York, are liquid and eager to establish long term relationships with small business owners. Draw down on funds when you need it. Expand, remodel, boost inventory, advertise, and fix aging equipment. In a tight race between you and the business next door, how much of a difference would it make if you received a $100,000 deposit one week from today? It would be a game changer and 'lights out' for your competitor.

Maybe you were on the fence for a Merchant Cash Advance in the past and decided against it. What if your competitor does it now? Perhaps it will cost them more than they hoped but their reward will be YOUR customers and they will win in the long run. It almost smells like the fine wine of capitalism that America is slowly losing, doesn't it?

Over $3 billion is estimated to have been injected into the economy though Merchant Cash Advance providers. The default rate on these is less than 15% on average. Recipients of the ARC loan are the real losers here. It is only a matter of time before the U.S. Government and economists recognize Merchant Cash Advances as being one of the core forces still driving small business growth and at no expense to the taxpayer.

When the repair shop down the street puts up a giant, shiny, new $5,000 sign to divert your customers away from your shop, waiting for that 4% interest loan offer to come back may take too long, if it ever comes back at all. Don't hold your breath.

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