As we’ve said before, every business could use a boost from time to time. By “boost,” we mean the working capital every business needs to do everyday business tasks like meeting payroll or buying important things like inventory. Alternative lenders have made working capital more accessible. Many of these lenders are relying on new metrics to determine your creditworthiness. As a result, more businesses are now qualifying for loans and lines of credit than ever before.
Although access to working capital can boost your business, you’ll want to avoid relying too much on this easy access. Taking out more than you can realistically pay back on a timely basis, and busting your budget, can lead your business into debt traps. In this post, we’ll share some tips you can use to avoid those traps and make sure you seek out additional working capital responsibly.
What is a “debt trap”
First, let’s be clear what we mean by debt traps. Seeking out and gaining additional working capital from time to time doesn’t automatically mean that you’ve fallen into a debt trap. If you’re consistently paying this money back you can avoid debt and have the money you need to keep your business going.
Unfortunately, easier access to working capital can lead some businesses to borrow irresponsibly. Depending on who you borrow from, additional fees and high interests rates can increase the amount you must repay. If you’re unable to repay the principal and interest on a timely basis—not to mention any additional fees—you’ve fallen into a debt trap you might find it difficult to escape from.
How Can You Avoid Debt Traps?
So what can you do to avoid a debt trap? Doing your due diligence before you seek out additional working capital can go a long way. Here are some tips you can use to avoid debt traps that don’t require you to do anything but be alert and ask questions.
Monitor your cash flow regularly to determine well in advance when you might need additional working capital.
Ask yourself whether you really need that loan?
Are you signing up for more debt or do you have a specific plan to use the additional money? Having a concrete plan can help you take out only as much as you need rather than the maximum you qualify for.
Avoid offers that sounds too good to be true
Sure, you might qualify for a loan within minutes. But that quick approval could also leave you trapped with debt you didn’t plan for because of high interest rates or other fees. Don’t be swayed by the marketing muscle of some lenders.
Know the true cost of that loan
Discover how much you’re really paying back to the lender. Does the lender reveal upfront any additional application fees, service charges, origination fees, recurring charges, or any other hidden fee that might be tacked on to the principal? Responsible lenders will be transparent about how much you owe and what contributes to that amount.
Ask the right questions of your lender
Is your lender on your side? You can find out by asking about things like early repayment. Some lenders charge exorbitant fees to pay off the loan early. Again, responsible lenders will be upfront with you about the total cost of your loan and any fees you might be charged along the way.