Stretch Loan: Meaning, Pros and Cons, FAQs

What Is a Stretch Loan?

A stretch loan is a form of financing for an individual or business that can be used to cover a short-term gap. In effect, the loan "stretches" over that gap, so that the borrower can meet financial obligations until more money comes in and the loan can be repaid. When offered by a federal credit union they may be called Payday Alternative Loans (PALs).

How a Stretch Loan Works

Borrowers typically obtain stretch loans from financial institutions where they already have a relationship and are in good standing.

For an individual, a stretch loan works much like the more familiar payday loan. With a payday loan, the borrower uses the money to cover basic living expenses or other bills until their next paycheck arrives. At that point, the borrower can, ideally, pay off the loan. Payday loan applications are subject to simple credit checks, and the loans are typically offered by small, but regulated, credit merchants. Payday loans are also notoriously expensive, with annualized interest rates that average 400%, depending on the state. Some states have now outlawed payday loans or restricted the amount of interest they may charge.

A stretch loan—while costlier than some other kinds of personal loans—typically charges a lower rate of interest than a payday loan. A major reason is that a stretch loan is normally available only to existing customers of a bank or credit union who have already demonstrated their ability to repay their debt. A stretch loan for an individual typically lasts for a month but could have a maximum term of six months if necessary.

A business might take out a stretch loan to provide it with working capital for a short period of time. For example, suppose a small company wants to buy fresh inventory to restock its warehouse but has not yet collected a large accounts receivable balance from one of its major retail customers. The company could take out a stretch loan from its bank to finance the inventory purchase. Then, when it collects on the outstanding accounts receivable, it can pay back the stretch loan.

The maximum loan amount will be limited by the lender and the interest rate will be higher than the rate for a normal working capital loan. A small business might not already have a working capital facility in place because, for example, it lacks sufficient assets to serve as collateral.

Pros and Cons of a Stretch Loan

Stretch loans provide convenience to the customer in time of need, but they can be much more expensive than traditional personal loans or working capital facilities. Interest rates are higher, and there are also likely to be application fees. So before applying for a stretch loan, the would-be borrower should make sure that there aren't more economical options available, possibly from that same lender.

Note that a stretch loan shouldn’t be confused with the similar-sounding senior stretch loan. That's a type of business loan that combines senior debt and junior (or subordinated) debt into one package and is most commonly used in leveraged buyouts.

The Bottom Line

A stretch loan provides money to cover a gap that you may have financially. However, it comes with interest rates and fees, so research other options, such as getting a personal loan from a family member or friend, or tapping into a retirement account that might have a lower interest rate, before committing to a stretch loan.