Small business loans from credit unions earned the second highest satisfaction rate from borrowers who received funding, according to the 2015 Small Business Credit Survey by the Federal Reserve Bank of New York. These loans may soon become even more attractive, thanks to a key change: personal guarantees (PGs) will no longer be required on all credit union small business loans.
This change was adopted when the Member Business Lending (MBL) regulation was revised recently by the National Credit Union Administration Board; it goes into effect mid-May 2016.
Personal guarantees require borrowers to agree to be personally liable for debts the business fails to repay. However, they can slow down the lending process, says Ryan Donovan, chief advocacy officer at the Credit Union National Association. “It’s a requirement that other lenders don’t have.”
The Problem With Personal Guarantees
Personal guarantees can be problematic for several reasons:
- Small business loan amounts tend to be much larger than those for personal loans, and therefore the risk can be substantial to the owner or executive who provides one.
- A business owner who signs a personal guarantee may remain on the hook for the loan after he or she has left the company if there is a balance, or if the loan is a line of credit.
- Personal guarantees often involve personal credit checks and those inquiries generally affect personal credit scores (rather than business credit scores).
- Sometimes loans with PGs will appear on the owner’s personal credit reports, affecting their credit scores.
Lenders, as well as vendors who extend trade credit, often want personal guarantees; after all, it gives them another avenue to collect if the business defaults. They are also seen as added incentive to get business owners to pay. But businesses with strong financials that establish strong business credit scores are often able to avoid personal guarantees by shopping for loans that don’t require them or by negotiating with lenders.
All things being equal, it’s best for entrepreneurs to avoid PGs when possible, but unfortunately, they aren’t always avoidable, especially when businesses are young and don’t have established track records.
Notably, the regulation change does not prohibit credit unions from requesting personal guarantees on small business loans; they may still be required by some credit unions, or on a case-by-case basis. “The rule takes things that were very prescriptive and puts the decisions into the hands of the boards of directors of credit unions,” says Donovan.
Another change: Credit unions that engage in business lending will be able to purchase loans from other credit unions, and those loans will not count against the purchasing credit union’s business lending cap. This is expected to help stimulate business lending among credit unions, and may increase their availability.
Benefits of Credit Unions for Small Business Loans
Because credit unions are not-for-profit organizations, small business loans from credit unions may feature lower rates than other types of business financing such as merchant cash advances or accounts-receivable financing. Many credit unions offer both secured and unsecured loans. Additionally, these institutions may be more attuned to the local economy and the needs of businesses in their community. In other words, they may be more willing to work with businesses that look promising, but are having a hard time getting financing.
In fact, during the recessions that began in 2001 and 2007, commercial loan growth rates for banks was negative, but remained positive at credit unions. (Commercial Lending During The Crisis: Credit Unions Vs. Banks by David M. Smith PhD)
On the other hand, there may be membership restrictions, and some credit unions may be limited in the number of business financing products they offer, especially when compared to the larger universe of 44+ financing products available to small businesses today.
Still, credit union loans are worth a look when shopping for small business financingespecially now.