There’s no doubt that small business borrowers could use some help navigating the loan process. Small business loan brokers claim to do just that, promising to check with lots of lenders so that the small business owner in question gets the loan that best suits their needs. Brokers’ promise of comparison-shopping would sound good to any careful shopper, especially busy entrepreneurs who want to focus more time on building their business than on searching for a small business loan.
Some brokers actually do help, offering sage counsel to small business owners to help them find the loan that best suits their needs. But, as we wrote about in Forbes last fall, small business owners are increasingly likely to encounter brokers who are out for themselves. In fact, unscrupulous players have emerged like wolves in sheep’s clothing, and are deliberately building tricks and traps into the loan process to pad their pockets and ensnare borrowers in a cycle of high-cost debt.
If you’re thinking about working with a commercial loan broker, here are 10 questions that you should ask your small business loan broker. Their answers will help you determine whether or not you’re dealing with a broker who will work hard to find a loan that fits your needs, or whether they are out for themselves.
1. Should I also be applying for SBA loans at my community bank or credit union? Deciding where to go for a loan, whether to an online lender or a community bank, comes down to what a small business borrower values most. Do you care more about securing the lowest possible interest rate? Or, do you care more about getting capital in under 48 hours, and going through a simple, user-friendly process that won’t require streams of paperwork? Your answer to that question should determine where you small business loan broker directs your loan. If you care about interest rate alone, banks and credit unions may be your best bet. Interest rates on small business loans at banks and credit unions can range from about 5% to 8% for term loans, which is among the lowest rates of any established credit product, whether offline or online. That’s why we always recommend that price-sensitive borrowers check with their local community banker before looking for loans elsewhere. But, bank loans can be hard to get for a lot of small business owners: approval rates at small banks and credit unions tend to hover around 50% versus just 20% for America’s larger banks. Moreover, you’ll have to keep in mind that the time required to go through a conventional loan process at a bank or credit union can often be intensive. The process is often so complex that it can take some business owners up to 72 full hours of paperwork and meetings just to get a decision on a loan from a bank, according to data from the Federal Reserve Bank of New York. So, if you’re not approved by a bank — or if you are but put a higher premium on speed and ease — then pushing your brokers to pursue loans from online lenders may be your best bet.
2. What’s the total cost of my loan? Can you express it to me as an interest rate and an APR? It’s first important to understand what an interest rate means. It’s essentially the amount charged to a borrower by a lender, expressed as a percentage of the loan amount. You can think of interest as essentially the rental charge that a lender charges to a borrower as compensation for lending money over the course of the terms of the contract, be it a few months or a few years. Interest rates are typically expressed as a percentage of the principal for a period of one year — also known as the Annual Percentage Rate (APR). But, sometimes they are expressed for different periods like for a month or a day. Generally speaking, interest rates get advertising attention, but you need to pay equally close attention to the APR for two reasons. First, the APR is the metric that is most often disclosed by banks and credit card companies, meaning it’ll allow you to compare online loan products with traditional credit products. Also, it’s because the APR includes the total cost to the borrower during the year expressed as a percentage of the loan’s value, meaning that all additional fees and closing costs that you may have to pay must be disclosed in the APR. That’s a big reason why lenders are now required to disclose APR in the mortgage industry as a result of Dodd-Frank financial reform. There’s no such requirement in the business lending space, but we push our lenders to disclose an APR and we encourage any business owner looking for a loan to encourage their brokers to do this as well
3. What additional costs are you adding to my loan? There are currently no federal or state rules about how much a broker can charge small business borrowers for a loan, and as a result broker fees vary dramatically in small business lending. Brokers working with community banks and credit unions, particularly for SBA-backed loans, tend to charge the lowest fees. These respectable brokers typically earn modest fees of 1% to 3% of the total value of a borrower’s loan. The best small business loan brokers will simply charge that fee directly to the lender, and the borrower will never have to pay for the brokers’ services. For example, that’s the model that we operate at Fundera, and we think it should be best practice in the industry. But, most brokers’ fees will get tacked onto the cost of a borrower’s loan, and often get immediately incorporated into a borrower’s interest rate. That is the model most common with brokers that facilitate online small business loans. But, most brokers don’t operate with this model, and borrowers need to be especially careful when dealing with their broker as we have seen their fees run as high as 20% of the total value of the loan. You’d think that a broker has an obligation to disclose that cost to the borrower, rather than trying to hide it as simply the cost that any lender will charge the borrower in question for lending to them, but brokers currently aren’t obligated to disclose their fees. We hope that will change with increased government oversight of the broker space, but until then it is imperative that every small business borrower ask for a full breakdown of how much their broker is making off their loan.
4. How many different lenders or funding companies will you shop my business to? It’s imperative that you ask your small business loan broker to shop your loan to as many lenders as possible, so that multiple lenders are forced to compete for your business. For example, at Fundera we always recommend that borrowers apply for at least 3-4 different lenders when seeking a loan because this introduces a competitive dynamic that helps us make sure borrowers get the lowest possible rate–and it’s what makes sure the borrower gets a rate that’s lower even than what that borrower would have gotten if they’d gone straight to the lender themselves. Ideally, brokers should then impart all of the offers to the borrower as clearly as possible, and let the borrower choose among those options free of pressure. If your broker tells you that they don’t recommend shopping your loan around because they already know where your best rate is going to come from, you should be skeptical. In some cases, this may be true, but generally speaking it’s always better to operate with a “trust but verify” mentality when dealing with a loan broker.
5. Do you make more money working with some lenders than with others? The reality is that broker fees are not standardized across small business lending. Some brokers and lenders effectively ‘collude’ with one another, meaning that some lenders offer brokers higher fees if they can send more qualified borrowers straight to them. This practice was very common in the mortgage industry in the lead up to the subprime mortgage crisis, where the spread that brokers earned was referred to as the yield spread premium. The Dodd-Frank Act made it more difficult for brokers and lenders to collude on charging yield spread premiums, but it does not apply to small business lending. As a result, you need to be vigilant. You should always ask your broker how their fee varies with every lender and product that they work with because you want to make sure that the broker isn’t trying to steer you into a loan where they reap the highest fees. For example, ask your broker to present you with multiple loan options from multiple banks, and then ask them to break out exactly how much money they will make on each loan as a percentage of the total loan as well as a dollar amount. And, make sure to remind them to include any closing costs that will be tacked onto the cost of a loan in addition to costs that get included in your interest rate.
6. Are your brokers subject to any code of ethics or principles for doing business? In most states nearly anyone can be a broker to businesses: there’s no test to pass and no code of ethics to follow. Most states don’t even have a cap on interest rates that can be charged to businesses. However, the best brokers have codified either internally – or externally – best practices for how brokers should interact with borrowers. For example, we explicitly disclose at Fundera what our borrowers should expect and indeed deserve every time that they interact with our customer success representatives, which is codified in our Small Business Borrower Bill of Rights. We encourage borrowers to take these ‘rights’ straight to any broker that they are working with, and push their brokers to agree to abide by and respect those rights as well.
7. What are the negative ramifications of the loan products that I am applying for? Small business loans can be tricky, and there’s no question that borrowers need some help navigating the 3-inch thick loan documents. Ideally, small business loan brokers should be able to educate you on the facts of a loan, conveying why it might be right for you and clearly explaining any potential pitfalls of the product. For example, perhaps the product in question will get the borrower capital in less than 48 hours, but that comes with a very high interest rate as a result. Moreover, because many online lenders don’t wish to disclose their interest rate in terms of an APR, which would make it easier for a borrower to comparison shop across other products, we think it’s incumbent upon brokers to do that leg work for their borrowers and let them know what the total cost of their loan is going to be. Ultimately, every borrower should push their broker to disclose negative ramifications of every product that they are selling, and if they can’t – or refuse to do so – borrowers shouldn’t deal with that broker.
8. Can I take some time to think about my decision before giving you my final answer? Loan brokers and salesmen only get paid when they close deals, which can create perverse incentives to close deals first and ask questions later. At Fundera, we have seen offline loan brokers and some lenders exert unfair pressure on borrowers, falsely claiming that their interest rate will vary dramatically day-to-day so they need to lock in rates immediately. We have even seen playbooks from prominent online lenders schooling brokers on tricks to steer borrowers into the highest-priced loan products. These practices are both unfair and predatory, and small business borrowers need to be on the guard for them. But, even more importantly, the process of obtaining a small business loan can be tedious and confusing, so no business owner should feel pressure from a broker or lender to sign on the dotted line right away. After all, prospective homeowners wouldn’t buy the first house that they see, so why should a small business borrower take the first loan they’re offered? Every borrower should consult family, friends, their local entrepreneurship counselor at a Small Business Development Center near them, and indeed other brokers or lenders before taking an offer. Typically speaking, you should ask for 48-72 hours to consider your loan options before making a final decision. If a small business loan broker or lender forces your hand any sooner than that, they’re looking out for their own interests more than your own.
9. Will you sell my information to any third party without my permission? About a year ago, while working on a research paper from Harvard Business School on the online lending space, I filled out dummy applications at a series of brokers to get a better picture of borrowers’ experience using their service. Within a week, my voicemail and email were flooded with companies wanting to sell me everything from electronic toothbrushes to used cars. Why? Because many brokers and lenders sell borrowers’ information without permission to anyone under the sun. That’s not just annoying, it’s misleading. Brokers and lenders shouldn’t be able to disclose or sell a borrower’s information to third parties without the explicit consent of the borrower in question. That’s why every borrower should find out if their broker will sell their information to third parties without their consent. If you ask your brokers this question straight up and they hedge, you should be wary. You should also pay particularly close attention to the fine print within their broker contract agreements, as often times brokers will slip deep inside these documents permission to do this.
10. How will you keep my information secure? When a borrower is applying for a loan, they’re handing over some of their most personal information, often times including their Social Security Number, Driver’s License Number, W-2 tax returns and bank account details. So, every borrower should ask their small business loan broker how they will keep their information secure. We think that borrowers deserve iron-clad security systems to keep their information safe, which is why we take reasonable measures, including firewall barriers, SSL encryption techniques, and authentication procedures, to help protect personal information from loss, theft, misuse, and unauthorized access, disclosure, alteration, and destruction. Borrowers have to acknowledge that no system is perfectly secure, but they need to ask how their broker will keep their information secure regardless.