What Are Employee Loans & Should You Offer Them? | Fora Financial
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What Are Employee Loans And Should You Offer Them?
March 16, 2021
What Are Employee Loans

What Are Employee Loans And Should You Offer Them?

Unfortunately, even well before the COVID-19 pandemic, many Americans were one paycheck away from running out of money. That situation has gotten even worse, with 63 percent of Americans living paycheck to paycheck as of December 2020.

With so many people so vulnerable to financial stressors, employees may look to their employers to grant them a loan.

Traditional employee loans are rife with potential for complications, especially for the employer. However, another kind of employee loan agreement, provided through a third party, removes many of those complications.

Still, no employee loan comes without costs and benefits to consider. Therefore, it’s a good idea to familiarize yourself with them before making any decisions.

To that end, we’ll explain what employee loans are, typical situations in which they’re provided, and their pros and cons. To wrap up, we’ll discuss potential alternatives to employee loans.

Employee Loans Definition

There are two types of loans both commonly called “employee loans.”

The first type of employee loan is money lent by an employer to their employee. The terms of this loan are set by the employer and can vary greatly. However, just like with a traditional loan, these loans generally come with an interest rate and they require repayment on a fixed schedule.

The second type is money lent by a third party through an employer’s benefits to an employee. Examples of companies that provide these loans are Salaryfinance.com and TrueConnect.

Typical Scenarios for Employee Loans

The scenarios in which an employee loan is asked for and provided are when the employee is experiencing some sort of financial hardship.

The precise details of these arrangements may vary because it’s up to the individuals involved—the employee and employer. Many employers, if they chose to make employee loans, establish policies governing which scenarios warrant a loan.

The Pros and Cons of Employee Loan Programs:

Pros of Employee Loans

1. This Type of Financing Can Help Your Employees

One of the most rewarding things about running your own business is the economic opportunities you create for others. In the same way, employee loans can help your employees get through rough patches. Even if you receive nothing in return, other than the repayment of your loan, providing a loan can be very rewarding.

2. May Help Attract Employees

The availability of employee loans can be a significant job benefit for prospective employees. This makes employee loans a potentially powerful recruiting tool. Plus, even if you don’t actually provide the loan amount, simply offering the possibility signals to recruits that you take care of your employees.

3. May Improve Productivity

An increasingly large body of research appears to show that financial stress may negatively impact worker productivity. Intuitively, this makes sense; more time stressing about money means poorer mental health, which translates into lower productivity. In the right circumstances, this financial assistance can ease the burden for employees.

Employee-Loans

Cons of Employee Loans

1. Time-Consuming to Administer

If you choose to make an employee loan it’s important to structure it appropriately. Otherwise, you leave yourself open to tax and other liabilities. Because employee financing must be properly documented, offering them means taking on another administrative burden. Of course, if you use employee loans through a third-party this burden may be alleviated, but not removed.

2. Relatively High Risk of Loss

If you lend money to an employee and they don’t pay it back, collecting it is going to be very challenging. Forceful solutions, including wage garnishment, are usually illegal. Also, going after the employee in court will cost you more than the value of the loan.

This means that if an employee is delinquent and they refuse to pay, you have little recourse. With third-party employee loans, though, this chance of loss is eliminated because the third party is in charge of collecting payment.

3. High Opportunity Cost

When you make an employee loan, you sink time and money into something that may or may not pay you back. Not only that, you have to redirect that time and money from something that could grow your business. Taken together, this means employee loans come with a high opportunity cost for employers.

Conclusion: Consider Your Alternatives

Before choosing to lend money to your employees, consider your alternatives. A paycheck advance or a third-party loan may be better solutions.

A paycheck advance gets money to your employees early so they can cover a shortfall. This method is a great alternative because your risk is limited to the value of the paycheck you advance. Similarly, the third-party employee loan takes the risk off of you and gets money to your employees.

Whether you choose to offer employee loans or not, make sure you’re seriously weighing the risks and the alternatives. It’s ultimately up to you but the decision shouldn’t be taken lightly.

Fora Financial

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.

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Fora Financial is a working capital provider to small business owners nationwide. In addition, the Fora Financial team provides educational information to the small business community through their blog, which covers topics such as business financing, marketing, technology, and much more. If you’d like to see a topic covered on the Fora Financial blog, or want to submit a guest post, please email us at [email protected].