Predatory lenders target individuals and businesses with poor credit who may be desperate enough to accept a loan that only digs their financial holes deeper.
People who come on hard times and need help fast may take on small loans with interest rates in the triple digits, owing tens of thousands more than they borrowed. An extremely high interest rate plus a prepayment penalty ensures that borrowers pay off the original amount quickly but still owe payments for several years more.
Small businesses can also become trapped in predatory loan agreements. Like people with poor credit or no credit, new businesses and startups have a hard time getting approved for loans or finding lenders that fit their needs, especially in underserved communities and for loans in smaller amounts. Small business owners may be tempted by these loans if the terms sound reasonable (but the fine print says otherwise), or if they feel they don’t have any other options.
There’s a difference between rates that are high but reasonable considering the risk, and rates that are only designed to make a fast profit from you. Business owners can be proactive in avoiding predatory loans by knowing the signs.
Predatory Loan Red Flags
- Unclear terms and prices. If the rates, fees, and terms haven’t been made crystal clear in a format you can easily understand, don’t sign. Predatory brokers are very good at dodging questions about what the loan will cost you. You shouldn’t have to prod them for this information.
- High prepayment penalties. Not all prepayment penalties are suspicious. A loan paid off too quickly loses money for the lender, and they need to keep the lights on, too. A reputable lender may charge a reasonable fee of 1-2% for paying your loan off before the terms are up. They may also allow for a certain degree of early prepayment but limit it to a certain time period. A predatory lender, on the other hand, might impose a high prepayment fee or offer to waive the fee in exchange for a larger loan amount, digging the hole even deeper.
- Too easy. In other words, if the terms seem too good to be true, they probably are. A reputable lender may be able to offer a faster-than-traditional approval, but a fair and reasonable loan requires documentation and detailed financial and business information. Would you do business with a company that doesn’t take the time to do its due diligence? Then why would you take a loan from one?
Before You Choose a Lender or Agree to a Loan
- Read reviews that are not provided by the lender
- Ask for rates and terms in writing from more than one lender
- Don’t sign any form with blank spaces on it
- Read and understand every word before you sign
- Have a trusted attorney, banker, or CPA look over the terms for you
- Ask for the average interest rate instead of the advertised “as low as” rate
No matter where you borrow, your interest rate is determined by how high the risk is of you not paying them back. The higher the interest rate, the sooner the lender recoups the original loan amount. This means that if you stop paying before you’re supposed to, they haven’t suffered too much of a loss.
But there are limits to what’s fair. The Small Business Borrowers’ Bill of Rights lays out what borrowers should expect from reputable lenders and provides a list of signatories (yes, you’ll find us there).
Fair financing is the key to stronger small businesses that grow to support their communities. The best lenders are partners, not just another bill to pay.