Employee Loans Explained

Employees remain loyal to employers who recognize and satisfy their requirements, financial security, and motivations for professional progress and job happiness.

What will your employee do if a bad life event totally affects their budget and their current income barely covers the cost? If something like this happens, workers frequently leave their jobs in search of higher-paying positions elsewhere or incur more debt to make up the gap.

However, there is an alternative that benefits both your business and its employees: employee loans. You can propose to loan employees the money they require at a substantially reduced interest rate rather than taking the chance of their returning to the labor market and achieving a higher-paying position.

What Exactly Are Employee Loans?

Employee loans are sums of money provided by the employer to help employees. Employees are required to pay back such loans to their employer, just like they would with a regular loan. The loan could be listed on the company’s balance sheet as a current asset if the entire amount is payable in a year. The loan is then regarded as a long asset on the corporate balance sheet if the period was more than one year.

How Do Employee Loans Work?

To prevent tax penalties and guarantee repayment, a loan agreement must be created. Follow these five steps to establish an employee loan program:

1. Determine the sum of money to grant dependent on the employee’s need and capacity for the payoff after carrying out interviews. Alternately, you might pay each employee the same set sum.

2. To fully assess the circumstances (such as the most your firm can manage to loan and also how frequently), speak with one‟s accountant as well as a company lawyer, then prepare the necessary agreement form.

3. Decide who will sign the papers and oversee payroll deductions as the administrator of your employee loan program.

4. Financial software can be used to manage fully automated salary deductions, record pertinent information, and make a payment plan for the employee.

5. Sign the documents and, if necessary, have a notary signing agent present.

Employee Loans: Key Considerations

Here are some factors you should take into account when drafting your employee loan policies:

• Conditions wherein a loan would be given – Employee loans will be made available for any cause, or only in extreme cases of financial need? Will there be any paperwork needed in exchange to be awarded a loan? Is every employee qualified for a loan, or is it just those who have worked for the business for a specific period of time? You must provide answers to these queries when drafting your employee loan arrangement.

• Amount of Loan – Set aside a certain sum of money to be utilized for the loan program if you’re planning to offer staff loans. Determine the exact amount you will lend staff as well. You can want that this is a fixed sum or a portion of the employee’s pay.

• Term of Loan – Employee loans often have shorter durations, no longer than two to three years. This is due to the fact that if a loan is now being returned over an extended period of time, it becomes tough to sustain a fund for lending.

• Method of Repayment – Payroll deductions are the most popular way to repay an employee loan. However, confirm that there are no restrictions on this kind of pay deduction under your state’s legislation.
  
  Before their job status changes, alternate payment arrangements can be made and repayments can be withdrawn from the employee’s wage or paycheck. The objective is to get paid on time or stop the employee from leaving without carrying out their contract.

• Additional Key Considerations – It’s critical that you have a promissory note prepared before giving employees loans. Your employee’s commitment to pay back the loan is stated in a promissory note. The loan’s repayment conditions, such as the amount, frequency, and interest rate, as well as what follows if the employee failed to repay, will be described in the promissory note.

Employee Loans: Pros and Cons

Pros

Offering employees loans could benefit your company in the following ways:

• Reduce workplace stress for workers – Financial problems like general debt, medical bills, education prices, or even just the cost of basic living can be stressful, particularly during a national emergency like the coronavirus epidemic. Employee loans could help your team focus on their work by reducing some of that tension.

• Increased output – An employee’s productivity may suffer as a result of personal financial concerns. Offering a break could help your business in the long term because staff would be better equipped to concentrate on their task.

• Increased loyalty – You might be able to increase staff retention by giving employees loans. Additionally, your business might develop a public image as a place of employment that appreciates and genuinely care for its workers.

• Assurance of resources – The cash flow can be improved by regular repayments of employee loans plus additional interest. Employee loans offer additional financial security for workers by acting as low-risk resources that can support them during difficult financial times.

• A cheap and low-risk lending option – Employee loans are a cost-effective and readily available choice for employees because they typically have lower interest rates than other types of lending and don’t call for a credit check.

Cons

Unfortunately, not all instances involving employee loans have pleasant endings. You can experience issues like the following:

• Risk of financial loss – There will always be a possibility that a loan will be repaid irregularly or sometimes not. It could be challenging to get your money back if the employee leaves. Before starting any employee lending programs, consider whether it would be a risk that your company can bear.

• Risk of conflict at work – An employee may experience uneasy working conditions if they owe money to their company. Additionally, if you give a loan to one employee, it’s probable that other workers will take it for granted. Your company can experience financial hardship as a result.

• Pressure to keep making loans – If they are still having financial difficulties, they might try to negotiate a longer loan period or a lower interest rate. Also, if the basis for their loan application was due to financial mismanagement, they can wind up becoming “repeat offenders” who frequently ask for more money. Just keep in mind that you are a company, not a bank.

Employee Loans: Alternatives

Advance on Paycheck

Providing your employees part or all of their following paycheck early limits the potential loss to one payment for your company and is a less complicated option than an official employee loan.

Retirement Plan Loans

Employees frequently borrow money from their retirement savings through retirement plan loans. One drawback is that, unless you use the money to buy a primary property, the IRS generally requires employees to return a plan credit within 5 years & make payments at least quarterly.

Make use of a third-party service

Motivate employees to choose a third-party business like Earnin rather than developing an employee loan program. Employees can receive a paycheck advance with Earnin without paying any fees or interest. 

Personal Credit Lines

Personal credit lines can have lower interest rates than credit cards, are less expensive than traditional loans, and don’t need collateral since they are unprotected lines of credit. They also have a smaller risk than credit cards.