The Business Line Of Credit Trap: Borrower Beware

writing-checkOver the past decade, there have been significant trends in the banking industry that you should be aware of. It used to be easy to get a loan for a new home or a new business as long as you had good credit and were willing to personally guarantee the loan. After all the problems began to surface in the banking industry and as the economy has continued to struggle, it has become more and more difficult to get business loans with reasonable terms. I even have some business banker friends who are considering changing careers because it has been so difficult for them to make business loans, even to established businesses with great credit.

Here are some pitfalls to watch out for the next time you think about applying for or renewing a business line of credit. 

1.Watch Out For “Demand Notes”

Most of the business lines of credit that are being offered these days are “demand notes”. This means that they have wording in the loan documents that allow the bank to basically call in the note at any time and demand full payment. In other words, you could be going along and making your payments just as you have agreed, and then one day, you get a letter that says “Please send us your entire outstanding loan balance within 30 days or you will be in default”.

This has happened to me and many other business owners before in the past, even with great credit, solid financials, and a long-standing business history. Any time you sign loan paperwork for a demand note, make sure you have a backup plan on how you will cover the outstanding loan balance in the event the bank demands full payment. In my scenario, I was able to get my loan refinanced with another bank. 

But what if another bank wasn’t willing to loan me the money? I would have been in serious trouble if I had to come up with the entire outstanding loan balance with just 30 days notice, unless I had cash on hand at the time to pay that amount in full. The same dilemma could easily happen to you, and is happening to other businesses all over the United States right now.

Just be aware that nearly all business lines of credit these days are really “demand notes”, and have wording in the loan document that gives the bank the ability to demand full payment of your outstanding loan balance at any time, and for any reason, even if you have great credit and are not in default. If you choose to move forward with that type of loan, make sure you have a contingency plan. 

2. Avoid Annual Renewals If Possible

A lot of the corporate lines of credit being issued these days have a one year renewal period. This means that the banks want your financials every year and they then revisit whether to renew the note, or to demand full payment of the note.

It is very time consuming to have to deal with annual renewals on a line of credit. The reason is because banks are pretty slow in renewing business lines of credit with all of the new governmental regulations. It can sometimes take months to get your loan renewed. You then have to turn around and start the renewal process all over again with the next year, sometimes just a few months after you got the last renewal finished.

I kept facing this issue with one of my banks, and finally demanded that they either give me a 3 year renewal at a time or I would take my business elsewhere.

If you are looking to establish any new lines of credit for your business, find a bank that will
give you multi-year renewal options as well. It is simply not efficient to deal with one year renewals on your lines of credit under any circumstance. I will never sign a loan document again that requires renewal every year. It’s a nightmare to manage, yet is the most common type of business loan being offered today from what I’ve seen. 

3. Never Do The Deal Just Because You Like The Banker

When you are choosing a bank to work with on a line of credit for your business, it’s fine to work with a banker that you like and trust. Just make sure that you don’t rely on anything that banker tells you as the sole reason for signing the loan documents. 

Your particular banker may be gone in the future with all of the turnover in the banking industry. That’s why it’s critical to make sure that the terms you get in your loan are something you can live with after that banker is long gone. You also want to make sure that everything the banker has promised you is accurately reflected in the loan documents that you sign, because it is the loan documents that will control in the event of conflicting information.

Please keep these 3 tips in mind as you seek any new lines of credit for your business. It may save you from some of the hassles that I and other business owners have gone through over the years. 

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