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. There’s a balance between rates that are high but reasonable considering the risk, and rates that are only designed to make a fast profit from you.
We’d like to take this opportunity to discuss how to tell whether a lender has your best interests in mind or not.
Hard working citizens, retirees, those who have survived or are living with illness, and even veterans who come on hard times and need help fast end up taking on small loans with interest rates in the triple digits, owing tens of thousands more than they borrowed. A preposterously high interest rate plus a prepayment penalty ensures that borrowers pay off the original amount quickly but still owe payments for several years more.
While some states govern payday loans and impose interest caps on certain small installment loans, these predatory loans are entirely legal.
Small business owners are often targeted by predatory lenders as well. Like people with poor credit or no credit, new businesses and startups have a hard time getting approved for loans, or even finding lenders that fit their needs, especially loans in smaller amounts, and especially in underserved communities.
According to Accion, small businesses are tempted by these loans because, “First, the language of the terms of the loan may sound reasonable but actually be anything but. Second, you understand the terms aren’t favorable, but feel you don’t have any other options.”
That doesn’t have to be the case. Predatory loans can be avoided, and there are other choices for businesses in need of financial assistance.
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 should not have to prod them for the information.
- A sense of urgency. If your broker is rushing you and being aggressive about getting you to say yes, chances are they’re only in it for their own profit, not your best interest. Accion adds, “Brokers can inflate the interest rate on your loan and call it a ‘yield spread premium’ to cover their fees. That means you’re paying more than you have to. Your broker should be upfront and honest about his or her fees.”
- High prepayment penalties. Not all prepayment penalties are nefarious–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. A fair lender 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, imposes a high prepayment fee or offers to waive the prepayment fee in exchange for a larger loan amount, digging the hole even deeper.
- Too easy. In other words, too good to be true, because it isn’t. 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 someone who doesn’t take the time to do their due diligence? Then why would you take a loan from one?
Alternatives when times are hard, and where to find reputable lenders:
• Microlenders like Accion or Opportunity Fund. Microloan rates vary depending on how much you borrow and your business’ financial circumstances, but when you connect to lenders through the Small Business Administration, they generally range from 8-13%.
• Credit unions can offer assistance in small amounts. Even if they turn you down, they will refer you to a reputable alternative.
• Use the Small Business Administration’s Lender Match tool to find approved lenders, like Lendistry, an SBA-approved lender.
• The Small Business Borrowers’ Bill of Rights lays out the expectations borrowers should expect from reputable lenders and provides a list of signatories (yes, you’ll find us there).
Before you choose a lender or agree to a loan:
• Google and 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
• Ignore the advertised “as low as” interest 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 they recoup the original loan amount, so if you stop paying before you’re supposed to, they haven’t suffered too much of a loss. But there are limits to what is fair. A loan with an interest over 30% needs to be scrutinized. Anyone with credit 600 and over with a profitable business should at least qualify for an SBA loan, which has rates capped around 10% depending on current prime rate, loan amount and term.
Most loans are advertised with rates “as low as” a certain, mostly single-digit number. Reputable lenders do this, too. Ask them not what their lowest rate is, but what their typical or average rate is, and ask how much you’ll be repaying in total when all is said and done. Get real answers and real numbers, or take your business elsewhere.
Fair financing is the key to stronger small businesses that grow to support their communities. Lenders are businesses who need to make money to pay their employees and stay open as well, but the best lenders are partners, not just another bill to repay.