Access to capital is crucial for small businesses to thrive, and the small business community is the backbone of the American economy.
Over the past few years, online lending has gained popularity among small business owners because of its quick approval time and flexible requirements even though at the end of the day, traditional banks will offer a business owner the best terms and the best deal.
While there are several advantages to alternative lending, it’s critical you carefully review and evaluate various loan products, so you don’t fall prey to predatory lending.
What is predatory lending?
By definition, it’s an unfair credit practice that results in harm to the borrower by fraudulently selling or pushing for an unsuitable loan to a small business.
While there are many kinds of predatory lending, one broad generalization that can be made is that a predatory lender does not require evidence of the borrower’s ability to repay the loan, according to Mark Rambler, president and chief operating officer of Credibility Capital, a New York-based firm that offers borrowers access to short-term business loans. For this reason, the rates and terms are onerous and often hidden.
Predatory lenders primarily target small business owners who: 1) need immediate cash for an emergency, 2) have a checkered credit history, or 3) are susceptible to being tricked into taking the burdensome product.
So how do you know whether a lender has malicious intentions to sell to you? Here are 4 warning signs that can help you identify predatory lending:
1. Unclear pricing and terms
The terms of the financing are not properly disclosed. They might be hidden, omitted or even falsely represented. Make sure to read the fine print of the legal contract – you would be surprised what some lenders include in their agreements, adds Rambler. If it’s not a simple interest calculation, you should ask why it’s not so simple.
2. Abnormal payment structures
It’s a balloon payment structure – lower payments upfront and a large payment at the end of the term. This dangerous arrangement may require the small business to roll into another expensive new loan to pay off the previous loan.
3. Too vague and complicated
A business owner should feel comfortable that he or she genuinely understands the loan product. If the lender is not directly answering your questions, try asking if they could describe the loan to you he or she were explaining to their child. Find lenders who offer a personalized, one-on-one experience.
4. Approval is too easy
The lender guarantees a loan will be approved regardless of credit history without a full underwriting; in this case, the lending product may be extremely burdensome.
Rambler says too often, he encounters business owners who convince themselves that while they understand their own small business, they just don’t understand financing. In order for business owners to set themselves up for success, it’s always important they budget their revenue and expenses such that their cash flow permits the repayment of the loan.
Put simply, the owner can protect himself or herself if he or she knows how much the business can borrow and how the business will repay the loan. The best defense against predatory lending is educating yourself and talking to a trusted financial advisor for further guidance and support.