Refinancing is just the first step: a holistic approach to helping clients escape the debt cycle
This is the second post in Inclusive Action’s “Doing Capital Differently” series, offering stories, lessons, and tips to financial services and CDFI practitioners from our experience of providing capital to underserved communities. Subscribe to the series!
by Lending Director, Andrea Avila, and Senior Underwriter, Alyssa Lopez
Camila came into the Inclusive Action office looking for a loan to help finance her business, and like many of our clients, she already had debt she was trying to pay off: a merchant loan with a 142% interest rate! The original loan was for $7,800, and at the end of the term, she would have paid $11,146.
“We need to first refinance your merchant loan,” we said, “for us to provide you with additional capital.”
Camila asked about her options.
Often, clients are surprised that we offer debt refinancing as an option. They are so accustomed to getting a bad deal or being told that a high-interest debt is their only option.
Some clients are turned off by the offer to refinance since they come to us with the specific aim of a loan, and refinancing (even high-interest debt which eases their payments) alters their initial vision for more capital and the uses of it.
“We need you to call the lender and ask them for a payoff statement.” The payoff statement is a document that lenders are legally required to provide. It’s different from a payment history because it tells people exactly how much they must pay and the amount of interest accrued daily.
Camila tried calling them to get the payoff statement, but the lender either wouldn’t answer the phone or kept putting her on hold. As a final tactic, she told them she wouldn’t pay — and they called back immediately. Because she had missed a payment, they told her she owed an extra $1,000.
“I want to pay the loan entirely,” Camila said. They immediately asked her where she was getting the money from. Merchant loans require access to the borrower’s business account, and they would have seen the transaction and treated our loan as business income, thus allowing them to increase the loan payment.
As underwriters, we serve not just as providers but also as coaches and educators. We sat on the phone with Camila twice a day for a week and coached her through the process, as many business owners don’t know what to ask for and how to ask. It was a lengthy and frustrating process, and once she got through to them and understood the payoff process, we deposited the funds into a separate account so it wouldn’t be treated as income.
Finally, we were able to pay off the debt. Camila told us that through the process, she learned how to advocate for herself while understanding the long-term cost of quick and easy capital.
The cycle of high-interest loans
As we wrote about in the first post in this series, Inclusive Action has always supported business owners like Camila by helping them refinance their high-interest debt. We regularly see clients with high-interest loans who are unable to get out of the debt cycle because of high weekly payments. And with interest rates as high as 114% for a title loan, clients can get stuck in compounding debts that can cost them up to three times the original amount borrowed.
“While their initial intention was not to refinance that debt,” we wrote, “we help them see the long-term benefits of refinancing and saving money on payments and interest, even if the results aren’t visible right away.”
Over the past year, according to a new report from the Federal Reserve Bank of New York, nearly 10% of credit card balances have fallen into delinquency, and 20% of borrowers are maxed out on their card limits, with a record $1.14 trillion in total debt.
Most of the debt that has been refinanced this year has been personal credit card debt, with interest rates between 26 and 30% percent, and personal loans used for business purposes, which usually carry an interest rate of 32 to 35 percent.
Unfortunately, a good portion of the loans we refinance are from other CDFIs that offer quick and easy capital to applicants, forgoing a more lengthy underwriting process. We strongly believe in the CDFI industry and stand behind its original civil rights mission. And yet what we’ve experienced is the need for a reminder of this, so we commend the US Department of Treasury’s CDFI Fund on updating the certification process to ensure that all actors are in service of the original intent of the industry.
We also understand that “high-interest” can be a subjective term, since the use of the loan and the state of the economy will likely influence the range of interest rates available. As we write this, the U.S. prime interest rate is 8.5%. This is the standard rate that U.S. banks will use to lend to applicants with “good” credit. In general, interest rates start getting tricky above 20%, and in California, lenders have a cap of 36%.
Credit cards are commonly the most expensive source of debt capital and usually the easiest to acquire. Mortgages typically have the lowest interest rates, and personal loans and student loans fall somewhere in the middle. There are also products like payday loans or merchant loans that have extremely high interest rates — as much as 114%. (Predatory loans that exceed California’s cap often operate out of states like Florida to skirt around the state’s regulations.)
With such high interest rates, our clients enter trapped within a cycle of debt. Camila maintained a regular payment schedule, but she still struggled to make a dent in her principal to the highest interest rates.
Why we target credit card debt
At Inclusive Action, we focus our support to micro businesses, which we define as businesses generating revenue of $750,000 or less. Our clients need startup capital to cover expenses, everything from production equipment to food inventory, alongside consulting fees like bookkeeping.
While there are many forms of loans a micro-business can get, like the merchant loan that Camila took out, sometimes the most readily available loans come in the form of personal credit cards. Many CDFIs don’t don't include the refinancing of personal credit cards because they don't qualify them as business expenses, but we’ve identified them as essential in the refinancing process we establish with clients.
For these reasons, we’ve found it important to target credit card debt — and, even more importantly, we work to help clients understand how the debt cycle works.
How we help clients escape the debt cycle
When we engage with a client, we sometimes know a loan would not work out unless we refinance the debt, especially when it comes with a high interest rate. While most clients come to us applying for a loan, they might be surprised to learn that refinancing is our first recommendation. Thus, we’ve found some additional education and support are essential.
Here are the steps we take:
1. Help the client see the value of refinancing.
The first step is sitting down with the client and helping them understand why refinancing is important. For those who’ve been in the debt cycle for a while, they are immediately grateful, because they know that getting out is really hard.
However, those who’ve been making steady payments or who are early in the debt cycle often need more information. They become more receptive when we explain that we will help them consolidate their debt at a lower rate, with a similar monthly payment, while still getting them some additional capital to invest in their business.
2. Refinance — along with some working capital.
We then advise the client on how to refinance at more favorable terms. We establish multiple deployments in order to confirm payment and guide them through the process, and in some cases, we pay the lender directly. We help clients understand pre-payment penalties and compound interest rates, so they fully understand what they’ve signed up for.
We aim to keep our interest rates low while helping our clients get outside the debt cycle. Inclusive Action’s rates, for example, land between 1 and 8 percent, and a lot of CDFIs charge between 10 and 12 percent, which is still considered within reason.
At the same time, we also loan them a small amount of working capital, in the range of $5,000 to $10,000, that they can apply directly toward their business and not toward their debt.
3. Establish an open line of communication.
Part of how we do capital differently is we establish an ongoing relationship with all of our clients. Our technical associates establish an open line of communication in case anything ever goes awry with their business. This way, clients know that someone on our team is willing to work with them to address the situation.
4. Develop workshops and ongoing education.
Right now, all loan applicants who refinance go through coaching with a business coach who has been certified on financial matters, so they can fully understand the cycle. We do this individually at the moment, and in 2025, we plan to roll out group classes and workshops for the topic of understanding debt, to help us scale our support for our growing client base.
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Camila was able to fully pay off her merchant loan, and now she’s working on a payment plan with us at a much lower interest rate. Her business is doing well and she regularly communicates with her business coach. That’s success to us, and we will keep going to ensure we can do it for others.