Unfortunately, even well before the COVID-19 pandemic, many Americans were one paycheck away from running out of money. That situation has worsened, with 63 percent of Americans living paycheck to paycheck in December 2020.
With so many people so vulnerable to financial stressors, employees may ask their employers to grant them a loan.
Traditional employee loans are rife with potential 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.
This post will explain employee loans and detail the most notable pros and cons. To wrap up, we’ll discuss potential alternatives to this loan option.
Employee Loans Definition
There are two types of loans, commonly called “employee loans.”
The first type of employee loan is money lent by an employer to their employee. The employer sets the loan terms and conditions, which can vary greatly. However, like with a traditional loan, these amounts generally come with an interest rate. In addition, they require fixed repayment terms.
Typical Scenarios for Employee Loans
Employee loans are offered to employees experiencing financial hardship or emergency expenses.
The precise details of these arrangements may vary because it’s up to the individuals involved—the employee and employer. If they choose to offer employee loans, many employers 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 your loan repayment, 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, making them a potentially powerful recruiting tool. Plus, simply offering it signals to recruits that you take care of your employees.
3. May Improve Productivity
An increasingly large body of research shows that financial stress may negatively impact worker productivity. Intuitively, this makes sense; more time stressing about money means poorer mental health, resulting in lower productivity. In the right circumstances, this financial assistance can ease the burden on employees.
Cons of Employee Loans
1. Time-Consuming to Administer
If you choose to make an employee loan, it’s important to structure it correctly. Otherwise, you leave yourself open to tax and other liabilities.
Because employee financing must be well 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 their balance may be challenging. Forceful solutions, including wage garnishment, are usually illegal. Also, going after the employee in court will cost you more than the loan value.
Therefore, 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 as the third party collects loan payments.
5. High Opportunity Cost
When you make an employee loan, you sink time and money into something that may or may not pay you back. In addition, you have to redirect that time and money from something that could grow your small business. Therefore, 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 to cover a shortfall. This method is an excellent alternative because your risk is limited to the value of the paycheck you advance. Similarly, the third-party employee loan takes the risk from you and gets money to your employees.
If you decide to offer employee loans, consider the risks and alternatives seriously. It’s ultimately up to you, but the decision shouldn’t be taken lightly.
Editor’s Note: This post was updated for accuracy and comprehensiveness in May 2022.