Employee Loans: Thinking About Giving One? Read This First

Sarita Harbour

Sarita Harbour

Sarita Harbour is a Small Business & Entrepreneurship Columnist at Fundera and a freelance writer and entrepreneur specializing in business and personal finance. A former financial advisor, Sarita has over a decade of experience in banking. Her work appears online at sites such as Forbes, Investopedia, Yahoo!, Capital One Spark Business IQ, and Business News Daily. Connect with Sarita on Twitter @saritawrites.
Sarita Harbour

Everyone knows that small business owners wear many hats—but most people don’t think that includes acting as a lender.

But if one of your employees asks for a loan, should you do it? And if you do loan a staff member money, how can you do it responsibly? Here are a few things to think about if you’re considering employee loans.

The Benefits of Lending Employees Money

Giving employee loans might actually have some benefits for your business:

  • Alleviating financial stress that makes your staff less productive because they’re worrying about money woes.
  • Building loyalty and improving morale within a small business or office.
  • Boosting your business’s reputation as an organization that cares about employees.
  • Contributing to employee retention and reducing turnover, according to a 2013 University of Colorado study on small and mid-sized contracting businesses.

It could be easier to decide to lend staff money if you have just a few employees that you know well, too.

Potential Problems Of Giving Employee Loans

Unfortunately, not all employer loan stories end well. Some of the problems you may run into include:

  • Your staff member might not make loan payments on time, or worse, not pay the loan back at all. And if they don’t pay it back, how large of an impact will it have on your business?
  • They could try to negotiate terms if they’re still struggling financially, lengthening the loan term or reducing the interest rate.
  • They may become “repeat offenders” with frequent requests to borrow more money if the reason for their loan request was caused by financial mismanagement. Just remember: you’re a business, not a bank.
  • If you offer an employee loan to one staff member, you might have to prepare for loan requests from other employees, too.
  • If the staff member quits, collecting what’s owed to you might pose a challenge.

Alternatives to Employee Loans

If you don’t want to lend money from your business, there may be a few alternatives that could help your employee when they need to borrow money.

Paycheck Advance

Chances are good that if your employee is asking you for a loan, they’re desperate. Maybe they’re faced with unexpected car repairs, medical bills for a family member, or even something like a surprise furnace replacement.

If that’s the case, a paycheck advance could be the answer. Historically, people in financial trouble would turn to their bosses for an advance on their paycheck, but according to a recent Society for Human Resource Management survey 2015 Employee Benefits: A Research Report, but this is becoming less common. Between 2011 and 2013, payroll advances by companies decreased from 21% to just 13%.

However, by giving your employee some or all of their next paycheck early, you limit your business’s potential loss to the amount of one paycheck, and it’s a simpler solution than a formal employee loan.

Retirement Plan Loans

Does your business offer 401(k) plans to your employees? If so, check into whether the plan is a “qualified plan” that might let participants borrow against their holdings. According to the IRS, in a qualified plan, “the maximum amount that the plan can permit as a loan is (1) the greater of $10,000 or 50% of your vested account balance, or (2) $50,000, whichever is less.”

5 Things To Remember

If you do decide to offer loana, it’s important to remember these 5 points to make sure everything goes as smoothly as possible.

1. Find out their needs

Ask your employee why they need the loan. Borrowing money for a one-time unexpected or emergency expense in one thing, but constant overspending and living without a budget may lead to a long road of being pestered to borrow more money.

2. Set expectations

Formalize your lending arrangements to protect your business. Establish guidelines for your employee lending program, because chances are that if one employee gets a loan from you, others will ask.

3. The Promissory Note

Have your employee sign a Promissory Note. Include the loan’s details—like total amount—and repayment terms—like payment amount, payment frequency, interest rate, and what happens in case of default.

4. Keep pristine records

Make sure that any loans from your business are recorded “on the books” so loan payments made by your employee aren’t mistakenly identified as business income.

5. Your Interest Rate

If the employee loan given by your business is over $10,000, charge an interest rate of at least the Applicable Federal Rate (or AFR). This interest rate gets set by the IRS each month. If you don’t charge this interest rate, the IRS could consider your business as having received “phantom income,” which is taxable.

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Small business owners often think of their employees as extended family members, and it’s hard not to sympathize when a family member struggles financially. Only you can decide whether it’s wise to lend money to your employees.

Whatever you choose to do, think carefully about how your actions will impact your business, your employee, and the morale and work environment of your entire organization.

Editorial Note: Any opinions, analyses, reviews or recommendations expressed in this article are those of the author’s alone, and have not been reviewed, approved, or otherwise endorsed by any of these entities.
Sarita Harbour

Sarita Harbour

Sarita Harbour is a Small Business & Entrepreneurship Columnist at Fundera and a freelance writer and entrepreneur specializing in business and personal finance. A former financial advisor, Sarita has over a decade of experience in banking. Her work appears online at sites such as Forbes, Investopedia, Yahoo!, Capital One Spark Business IQ, and Business News Daily. Connect with Sarita on Twitter @saritawrites.
Sarita Harbour

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