The pain of fast money
- Written by Kim Moore
- Published in Economy and Finance
- 2 comments
Fintech companies come under fire for predatory lending.
“You can see the desperation in their eyes,” says Linda Tran, a loan manager at the Micro Enterprise Services of Oregon (MESO), a nonprofit that lends to low-income and underserved communities. The people Tran describes became buried in debt as a result of borrowing from fintech companies.
In the past six months, several business owners have sought financial help from the nonprofit to escape the heavy debt burden they have become mired in after borrowing money from non-bank online lenders. These fintech companies lend money at higher interest rates than traditional brick-and-mortar banks, and often in exchange for big fees.
Professionals in the small-business lending sector say it appears there are more non-bank online lenders than ever before. And in an increasingly digitized economy, where anything can be bought online, cash-strapped small-business owners, especially minority-owned businesses, are falling into the trap of borrowing at unsustainable payback schedules or at exorbitant rates.
The loans are tempting to borrowers who need cash quickly because fintech companies often require minimal background checks. Traditional banks lend money at lower interest rates, but the process is longer and often requires the borrower to submit a business plan, tax returns and other paperwork. Fintech companies, which do business entirely online, can turn around loans in as little as 24 hours.
“We live in a time where people are used to picking up the phone, ordering something and getting it the next day. Fintech and online lenders attempt to match that pacing. You just don’t get a reasonably-priced cost of capital in that scenario,” says Noah Brockman, strategic advisor at the Oregon Small Business Development Center.
Some online lenders charge interest rates that are as high as between 25% and 30%. Tran says she discovered that one client, who approached MESO to restructure debt, was paying interest only for the first six years of a 10-year loan. Another client, who took out a 6-month loan for $20,000, would end up paying between $28,000 and $30,000 at the end of the loan term.
Many small business owners are also getting into financial trouble because of a form of lending called merchant cash advances. These short-term financial arrangements require the borrower to pay back the money owed as a percentage of the borrower's daily credit card sales (typically between 10% and 20%).
Merchant cash advances can quickly drain a small business’s capital because money is often taken from the account every business day. And because they are not considered a loan, the borrower cannot receive a discount for repaying early.
Ana Inclán, senior business lender at Craft3, a nonprofit lender, says she is seeing more business owners use cash merchant advances to fund everyday business needs, such as meeting payroll. “It is new to be using it for random cash needs,” she says.
Sabrina Parsons, CEO of Palo Alto Software, has seen how detrimental fintech loans have been to entreprenuers that are starting new businesses. The Eugene software company provides strategic planning to the sector. She says many companies come to the firm's website seeking to access capital because as startups they can't get traditional bank loans.
"It’s kind of a red flag. Fintech has been a great thing but it’s very unregulated. There are some great opportunities, but also a growing number of companies are taking advantage of small businesses, because we don’t regulate business lending the way we regulate personal lending," says Parsons. "They’ll give them immediate access to cash but it’s at a super high interest rate with really unfavorable terms. It becomes a really big hurdle for small businesses."
Some fintech companies are clear about rates and fees, while others are less so, says Brockman. “The biggest need is borrower education so people know what they are getting into. Hopefully the agreements they are signing for online loans are transparent about the fees and interest rates.”
Minority- and immigrant-owned businesses are particularly in need of education about predatory lending practices. This is especially the case as fintech companies have been known to try to recruit native speakers to sell products to other people who speak their language.
“If somebody is lending you money, they should be asking you tough questions,” says Inclán.
While mission-driven nonprofits like MESO and Craft3 can sometimes help business owners restructure their heavy debt loads, many are too indebted to receive assistance.
“I am sometimes able to help, but for the rest it is too late. They have no ability to pay back,” says Inclán.
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Ben M. Wednesday, 17 April 2019 11:59 Comment Link
We see this constantly at Mercy Corps NW. We are a non profit working to support underserved local small businesses through training, grants, and loans.
Here is a real-life client example. A client takes out a merchant cash advance for $11,000. The finance charge is $4,500 (notice this isn't an interest rate). This means the client will pay off $15,500 total, regardless of how fast they pay. There is no incentive to pay off early and reduce their interest expense as with other loans. They are stuck paying $15,500 once they sign and are locked in.
The repayment mechanism is 15% of daily sales. Based on this particular client's level of sales, he will repay in about 10 months. If we put this in terms of a simple interest rate calculation, this lands right around 80%. 80%! How is this legal?
These are SO easy to get into, and almost impossible to get out from underneath. My heart sinks whenever I speak to a client who has one of these, and unfortunately this is becoming more and more common.
Robin Wang Tuesday, 09 April 2019 12:00 Comment Link
We're a CDFI that does small business lending and about a 1/3 of the clients that we encounter have one of these loans on their balance sheet. It’s an epidemic that I’ve called analogous to opioids. They are so easy to get and business owners get instant relief from their cash flow pain (creating a “financial high or euphoria”) but for some they get addicted to the fast and easy money that they can’t stop even though these loans suck the profits and long term cashflow from their business. And because there are so easy to get, they hide the symptoms and root causes of why the business doesn’t have sufficient cash until it’s too late.
In addition to high interest rates, our clients have said the following:
+ Weekly or even daily auto withdrawals from bank account leave little room for times with cashflow might be lean.
+ Interest / fees are locked in no matter if you repay early
+ No clear, upfront disclosure of terms, fees, etc. They are either buried in fine print and/or presented when they are one click away from submission / approval (temptation is really strong).
+ A single late payment can trigger a cascading bunch of unrecoverable fees and conditions creating a deeper hole to get out of.
We’ve also seen these lenders be VERY slow on releasing UCCs when the loan is paid off making it more difficult to secure future financing. I also suspect that they do this because the likelihood that the client will come back for additional capital is high and so by not releasing the UCC, they maintain their position.