It is quite a common practice for businesses and individual to resort to loans and other forms of financial assistance whenever the need arises. But because when it comes to loans the options are almost endless, with new financial assistance schemes being launched almost every year, it becomes very difficult for individuals and businesses to differentiate one particular kind of loan from the other. It is our purpose, therefore, to discuss two common loan types and hence distinguish between them. These are installment loans and merchant cash advance. Although one of them, merchant cash advance is not technically a loan for reasons that would later become apparent, we include it in our discussion because it serves the same purpose as a conventional loan: providing cash to persons as and when needed, and it is also repaid at a later date based on agreed terms. We shall begin our discussion, however, with installment loans.
Understanding What Installment Loans are and how they differ from similar loans
Installment loans are not something new; they have been around for more than a hundred years and have been known to provide little cash to customers in order for them to purchase goods and services of their choice. Some Installment lenders operate offline while some operate their businesses online. It is often advised, however, that consumers stick to partnering with only those whose offices can be verified and with only those that are close them—preferably those with offices in their states or cities. Installment Loans are primarily consumer loans and they often do not give beyond $5000 at once to a single customer. Installment lenders are duly recognized by both federal and state governments and are regulated. The loan which they provide is actually meant to be repaid through equal monthly payments known as installments. The manner in which the loan is structured makes it somewhat different from those offered by traditional financial institutions such as commercial banks.
Installment lenders are known to work hand in hand with the borrowers to make sure they only take loans which can easily be repaid. One way they do this is by analyzing the monthly income and expenditure of a potential borrower in order to determine whether or not there is a significant amount left after the expenditure to be channeled towards the repayment of the loan. Unlike loans from other financial institutions, installment loans are designed to be paid with the excesses of a customer, that is, what is left after expenditure every month. It is only if, and when the lender is satisfied that a potential customer can finance the loan comfortably that the loan is granted. One other feature of such loans is that their penalties are not charged for early payments nor are they charged for prepayments. The loans are also structured so that a part of the monthly payment is used to offset the capital while the other part is used to pay off the interest. Above all installment lenders report the behavior of a borrower to credit bureaus and this can help boost or diminish an individual’s credit score.
Distinguishing between Installment Loans and other similar loans
For some reason, Installment loans are often confused with other loans such as payday loan. Payday loans are an old form of a loan that most working class people have obtained at one point or the other during their careers. The reason most workers might sometimes seek small-dollar loans differs but usually hover around a few things. In most cases, it is as a result of unexpected expenses, but others opt for them as a result of misaligned cash flow, or because they had exceeded their budgets and are trapped or because they wish to make a [purchase which they cannot afford at once. A payday loan for simplicity is a cash advance that is secured by a personal check, or one in which the lender is authorized to make an electronic transfer from the borrowers checking account. The main similarity between an installment loan and this kind of loan is in the small amounts that are usually involved and also the purpose for which the loan is obtained. In addition, they are both short-term loans, requiring borrowers to repay the loans as quickly as possible
But, there are some major differences. First, a payday lender usually demands access to the borrowers’ checking account in order to enable it to cash the money once the time for repayment—payday—arrives and the customer is unable to pay. In order to obtain a payday loan, the customer writes a postdated check to the lender and this is the only requirement alongside having a job which the lenders require. Payday lenders do not underwrite loans to ascertain the creditworthiness of an individual since the check already provides security for the lender. This is in stark contrast to what obtains in installment loans as lenders do not require access to checking accounts before a loan is granted. Payday checks do not also develop manageable payment schedules and require lump one time payments. And if for any reason the check could not be cashed at the due time, the payday loan is rolled over and becomes a new debt, creating a cycle of debt.
Introducing Merchant Cash Advance
A merchant cash advance, on the other hand, is something quite different from a loan in the strict sense of the word. Unlike an Installment loan, a merchant cash advance as the name implies is a loan so to speak that targets businesses and not private individuals. A merchant cash advance is a commercial transaction involving a borrower (merchant) and a lender (merchant cash advance provider). In this transaction, an agreement is reached in which the merchant sells a portion of his future credit sales in exchange for a lump sum of cash from the merchant cash advance provider. A MCA loan does not attract interest because it is a sale. What this means is that since the cash that the merchant cash advance provider offers to the business will be worth more in the future when it is debt free, the future credit sales of the business is offered at a discounted price. This is what results in what is known as factoring in a MCA agreement and it is also what enables the merchant cash advance providers to make a profit.
Certain Key Terms in Merchant Cash Advance
There are certain terms that do not feature in an installment loan transaction that is found within merchant cash advance agreements. The first of these is the factor rate. The factor rate is the amount by which the cash advance given to the merchant is multiplied in order to obtain the total amount which the business is expected to pay back. The factor rate is usually determined by the amount of cash advance which the merchant seeks, the nature of the business, and any other factors which the particular lender might choose to consider. The withholding amount is the portion of the daily credit card sales which goes into the repayment of the debt. This amount can either be in the form of a fixed percentage often less than 20 or a fixed sum of money that is paid to the lender regardless of the circumstance of the business—that is whether sales are climbing or drooping. Once agreements on factor rate and withholding amount have been made, the debt is paid from the credit sales on a daily basis until it is repaid in full.
Why Have Small Businesses Found Merchant Cash Advance so Attractive?
Unlike Installment loans, merchant cash advance is unsecured. This is to say that a borrower assumes no personal risk in getting a MCA. The merchant cash advance provider is the one who bears all the risk, and eventually loses his investments if the business fails. Even in cases when some merchant cash advance providers obtained personal guarantees from business owners, courts always ruled in the favor of merchants, stating that MCA lenders cannot obtain security of any sort as a MCA is not a loan. In addition, getting a merchant cash advance is easier compared to installment loans, with a typical merchant loan being processed and delivered in a few business days. And if there is one thing that has endeared business owners to merchant cash advance it is the fact the with a poor credit score a loan can be granted provided that the businesses raise enough revenue—about $5000 minimum—a month to finance the advance. Above all, a merchant cash advance can be used to purchase equipment, inventory, or for any purpose that suits the needs of the business.
Our examination of both installment loans and merchant cash advance makes it quite clear that while the former is more of a personal loan, the latter is meant for small businesses which are in need of capital to grow. One reason for this is that installment lenders only provide small amounts, much less than what a small business would typically need. In a nutshell, a merchant cash advance is the better option of the two when it comes to small business loans.