Having trouble getting a bank loan for your small business? So are many other small companies, especially those in economically disadvantaged areas, according to a report released Tuesday January 24. That lack of traditional bank financing has led to a proliferation of online small business lenders. But experts warn: be careful.
“Overall, the total number of (small business) loans in 2014 was down nearly 60 percent from the peak in 2007,” according to the report “Patterns of Disparity,” conducted by the Woodstock Institute in partnership with the Main Street Alliance, California Reinvestment Coalition, and People’s Action Institute.
“Since the Great Recession, mainstream financial institutions have reduced their small businesses lending, leading some businesses to resort to alternative, non-bank financial technology (fintech) lenders for needed capital,” said the report’s author. “An analysis of loan terms and satisfaction surveys of business owners suggest that high interest rates, onerous terms, and relatively poor customer service are unfortunately common among such providers.”
“Only one in five small business owners seeking financing from a traditional bank will get approved,” said Nonso Maduka, who leads small business efforts at NerdWallet, a website comparing various financial products. “That leaves 80 percent who can’t get funding from a traditional bank source, even though that’s likely the lowest cost.”
And, as the Woodstock Institute reports, the chances of a small business in an economically challenged area getting a loan from a bank are even lower. Nationally, businesses in low-income areas comprise 9.3 percent of all businesses but received only 4.7 percent of bank loans under $100,000.
“If you’ve gone through the process of applying for a bank loan and aren’t eligible, you haven’t been in business long enough, the amount of money you’re requesting is less than $500,000, if you’re thinking about speed, or just need cash in order to keep moving, an alternative lender might be a good option,” said NerdWallet’s Maduka.
“But, as with any new industry, there are no clear regulations yet,” warned Maduka, meaning small businesses need to be careful, even wary, when considering one of these online business loans.
If you’re thinking of taking out one of these online loans, what should you consider:
- Lack of protection. Small business borrowers, whether getting an online loan or using a business credit card, don’t have the same protections they do as when borrowing as a consumer. Fintech is called “the wild west” of borrowing, so don’t expect the same limits on interest rates, requirements for transparency, or other government protections.
- Sky-high interest rates. Loan sharks would be comfortable with most of the interest rates charged by these lenders. Annual percentage rates (APRs) average around 94 percent and reach as high as 358 percent according to a report from The Opportunity Fund. Who ever thought a 28% APR on a consumer credit card would look good?
- Terms and fees. Many of these loans have hidden fees or onerous terms. Check those carefully. For instance, you may have to pay the entire interest rate even if you pay the loan off early, have additional fees, or are required to maintain certain daily cash flow requirements or incur additional charges.
- “Stacking.” Stacking is taking on new debt to pay off old debt. “The onerous terms of the previous debt weigh on your business and you can’t make those payments, so you roll that in to a new loan which also might be a high interest rate,” said Maduka. “Unfortunately there are companies out there that prey on this factor… …that’s how they make money.”
- Repayment sources. With such sky-high interest rates – and often additional fees – you want to make absolutely certain you’re going to be able to pay these loans off on time. Don’t use as a last resort when you’re in trouble, but only when you have a clear, dependable source of funds coming in.
Finally, though you should be wary of these online loans, if you decide you have no other alternative, be sure to shop around. “Most small business owners don’t comparison shop when looking for loans. They just go with the first choice because they need cash right now or they need to get back to what they’re good at—running their small business,” said Maduka.
Copyright, Rhonda Abrams, 2017
This article originally ran in USA Today on January 25, 2017