Mar 20, 2018 Philip Burgess
As more small-business owners launch companies - 25 million Americans have started one within the past two years, according to figures from Babson College - many are finding success, but at the same time discovering that keeping their doors open costs more than they originally anticipated. To rectify the cash-flow shortfall, some are taking out second loans, thereby defraying these operating expenses.
But with more lenders to choose from, some are borrowing from multiple providers, taking advantage of more affordable interest rates in the process. Some don't stop there, taking out additional loans, sometimes to pay for the originals.
The strategy is called loan stacking, and while the activity has surged in recent years, its fraught with risks and land mines that can backfire for lenders who engage in the practice, even when borrowers pass the underwriting process with flying colors.
What is loan stacking?
As its title implies, loan stacking is where a borrower - typically a small-business person - already has a loan that's in effect but goes to a different lender and takes out another. There are public records that lenders can examine to see if a loan already exists, but in their haste, they may decide not to do their due diligence for fear of losing out on the business to a competitor.
"Stacked loans are four times more likely to be fraudulent."
Loan stacking is not illegal. Many online lenders have protocols in place that help them determine whether borrowers have the means to pay off what they've borrowed. The problem, though, is these underwriting methods are not foolproof, and those taking out loans frequently may have no intention of paying them off. Indeed, according to credit agency TransUnion, stacked loans are four times more likely to be fraudulent compared to loans where only one exists. In fact, of the $497 million that fintech lenders lost out on in 2015 - known in the industry as "charge-offs" - $39 million of it was attributable to stacked loans.
Brian Biglin, chief risk officer for a mortgage lender, told Reuters that this type of lending activity is having a variety of repercussions, many of them adverse in their impact.
"[It's] causing problems with the whole industry," Biglin warned.
As noted by TransUnion, lenders are increasingly relying more on the internet, which only adds insult to injury. Going online helps to lower their operating costs, but because verification methods tend to be more lax, it affords fraudsters an easier ability to game the system.
Stacked loans may be on the up and up
This isn't to suggest that all stacked loans are fraudulent. Edward Hanson, owner of a Washington, D.C.-based pizza parlor, told Reuters this type of financing enabled him to keep his business afloat. The second lender Hanson borrowed from knew of the existing loan and met the qualifications he needed to satisfy to take out another. However, he's paying a much higher interest rate on the second.
But scammers often understand the higher interest rates that apply, and concoct phony identities to avoid detection once lenders discover they've been swindled.
Pat Phelan, senior vice president at TransUnion, told American Banker that phone companies have frequently been targeted.
"They'll open a mobile account, get a billing address on that mobile account, then they'll head towards traditional non-fintech borrowing, then they'll head towards card and fintech," Phelan warned.
Phelan says there are several ways to reduce account opening fraud - and, by extension, fraudulent loan stacking - by maintaining robust lending standards and increasing coordination and collaboration with other lending entities.
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