The Pitfalls of Online Lending and the Importance of Media Exposure
On Monday Michael Corkery penned a piece in the New York Times that shed a much-needed light on the pitfalls of online lending for the unwary borrower. A powerful piece, the article primarily opines on the dangers of automatic withdrawals from bank accounts, or as the online lending industry likes to call it, “ACH.” To put it simply, this means the loans are being paid back daily, weekly, or monthly by an automatic draft out of a borrower’s bank account. Borrowers are not sending the payment in themselves online or with a check. The process becomes entirely automatic.
Corkery cites several examples on both the consumer and business side that reveal how ACH can make it much more likely that cash-strapped borrowers will pay off their loans before their living expenses. Alongside this, he highlights one of the technical pitfalls of automatic withdrawals — it can even take place post-bankruptcy or in instances where a borrower has zero funds in their account (or NSFs/non-sufficient funds in lender speak).
The biggest “pro” of ACH payments is convenience, for both the borrower and the lender. But, Corkery hits it on the head, showing how imperative it is for prospective borrowers to understand the positives and the negatives (see above) of automatic withdrawals.
We applaud Corkery on detailing this lending practice, but we think it’s also important to note that this is just one of many, many pitfalls a borrower can incur when acquiring a loan through an online lender. Unfortunately, there is very little literature on the web that educates borrowers on the subject matter. Hence why it’s so great to see an institution like the New York Times diving into the topic. But, this is just the tip of a potentially very dangerous iceberg, and it’s critical that credit-seekers deeply understand the traps of online lending.
There is an incredibly long list of pitfalls awaiting borrowers, particularly those on the small business side, where there is less regulation. The repercussions of these pitfalls can be severely egregious.
We’ve been writing and advocating extensively for “borrower awareness” at Fundera. We think it’s absolutely crucial borrowers know about these pitfalls. I encourage the elite media to continue this important conversation, championing the borrower, and preventing them from being fleeced instead of being helped.
Here is a deeper checklist of pitfalls a potential small business borrower should keep in mind when looking online:
1. Daily ACH vs. Weekly, Bi-Weekly, or Monthly
One of the most popular products found online are short-term loans. These loans tend to be 3 months to 18 months in length, and are paid back with daily ACH. Although this can be a good solution for some borrowers, for others it can drastically cut into their cash flow, making it very difficult for them to conduct business. If a small business is considering a short-term loan, they need to think carefully about how this will affect their cash flow day-to-day.
2. Factor Rate vs. Interest Rate vs. APR
Every online lender quotes their cost differently. Some quote their fee as a factor rate, some as an interest rate, and some as APR. But, there is a reason why credit card companies are legally obligated to quote their fees as APR — it’s the best way to represent the true cost of borrowing, and the only way to compare different products on an apples-to-apples basis. APR accounts for both interest and fees associated with a loan, so no borrower should commit to an offer before knowing what the APR is.
3. Pre-Payment Penalties
Perhaps a borrower enters into a high-cost loan in order to pursue a very specific business opportunity. They know they’ll have a huge influx of cash quickly after the opportunity, and can pay back the loan almost immediately when that happens. However, many lenders will penalize borrowers for doing this. Meaning, they can pay back the principal, but will still have to pay back a certain percent of the interest owed. Worse yet, there are certain merchant cash advance providers that will not let you pay down your advance early, which can prevent you from accessing better credit elsewhere. It’s imperative small business owners understand if this is part of their deal, especially if they had plans to pay back the debt early.
4. Origination Fees
Many borrowers are completely unaware that lenders can charge extra fees on top of interest. You might think you’re getting a great deal, but then realize you actually have to pay another 4% to make it happen. Perhaps you were comparing two offers from different lenders, and thought you were moving forward with the lowest-cost option. But, after learning about the “origination fee,” you realize that the other option was actually cheaper. To reiterate, this is why knowing the APR of a loan is so important. It helps you truly understand the total cost involved and make real comparisons.
This list is by no means comprehensive, and does not even begin to address the dangers of working with unscrupulous commercial loan brokers, but it is a start and should help provide borrowers with a solid foundation of what to know before applying for an online loan.
Hopefully we see more pieces like Corkery’s. Borrowers deserve to be empowered with information to make educated decisions, ensuring they find the best, and most responsible, loan available to their business.
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