How Lenders Can Mislead You With Their Contracts

Georgia McIntyre

Georgia McIntyre

Finance Writer at Fundera
Georgia McIntyre is the resident Finance Writer at Fundera. She specializes in all things small business finance, from lending to accounting. Questions for Georgia? Comment below!
Georgia McIntyre

The world of small business financing can be a confusing one. With so many terms and calculations, it can be tough to keep everything straight.

And we don’t blame you—just because you own a small business doesn’t mean you’re a business financing genius.

One of the most crucial—and confusing—steps to getting the right financing is understanding your contract. But how can you really know what that financing will mean for your business if lenders are communicating information in a misleading way?

Well, you can start by knowing how lenders can mislead you with their contracts, so you know what to look out for when you’re securing a small business funding.

What to Watch Out For: The Total Cost of Your Financing

When it comes to the total cost of your financing, there are tons of terms that might be thrown at you in a contract. Interest rate, factor rate, APR… What do these terms really mean, and how are they different from each other?

Those are good questions—and we’ll answer them later.

Understanding the total cost of your financing can be confusing when every online lender quotes their costs differently. And unfortunately, with all the different ways to present the cost of your funding swirling around in your head, it’s easy for lenders to mislead you in their contracts—prompting you to take on expensive financing that you never would’ve agreed to if you actually knew how much it was going to cost you in the end.

The Power of Language

How exactly can lenders mislead borrowers on their contracts?

Well for one thing, they can use misleading language that doesn’t actually reveal what a borrower will have to pay back in full.

Here’s An Example…

Take a look at an example that actually happened.

A lender gave a contract for financing with the amount given as $27,900, and said the borrower had to pay back $37,300 in total.

On the contract, the lender listed the “payment percentage” as 12%.

So the interest rate was 12%, right?

Not at all. If you do the math, the amount the borrower was supposed to pay back was actually about 34% more than the funding amount they were given in the first place.

What did that “12%” really mean?

The 12%, called the “payment percentage,” was just the proportion of the borrower’s daily sales that the lender wanted to take out of their bank account. So this borrower repaid 12% of their earnings until they repaid a total amount 34% greater than what they were given.

Tricky, right? This is a real life example of a lender using misleading language on a contract—misrepresenting what the total cost of the financing will actually be. While this example of payment percentages—which works just as well for the factor rates that come with merchant cash advances—aren’t actual lies, they can easily mislead borrowers into thinking that their financing is cheaper than it actually is.

Interest Rate vs. APR—What Should You Pay Attention To?

Lenders can use an interest rate or an APR to quote the price of your financing.

But what’s the difference?

Well, an interest rate is the cost a business owner pays to borrow money from a lender.

An APR, or your annual percentage rate, gives you a more comprehensive look into what you’ll pay in the end: it represents the actual yearly cost of funds over the term of your financing. Your APR includes your interest rate, plus any other fees that you’ll end up paying your lender—including origination fees, application fees, closings costs, and so on.

Because an interest rate will almost always be lower than the APR, lenders can mislead borrowers on contracts by not quoting the financing price as an APR.

Here’s An Example…

You’ve just received your contract and you’re trying to figure out how much your funding is going to cost you.

Here’s what you know:

You’re borrowing $10,000 over a 2 year period and your interest rate is 12%.

You might be thinking that you’ll end up paying $11,200…

But then you read further into your contract and find, in the fine print, that you’ll also be paying a $500 origination fee. That cost is going to be wrapped into the total cost of your funding, but isn’t represented in your 12% interest rate.

So what’s the total cost of your financing?

Don’t be mislead by the advertised interest rate—you’re not repaying $11,200. In the end, your APR is 16.92%. The total cost of borrowing? $1,692.

Unfortunately, borrowers agree to financing based on their quoted interest rate instead of APR all the time—and they end up paying much more in the total cost.

Using APR to Understand the True Cost of Your Financing

In order to be fully informed, you should pay attention to both the interest rate and the APR.

You can use your interest rate to get a quick understanding of what you’ll repay your lender. But it’s the APR that will really matter in the end.

There’s a reason why companies in the credit card and mortgage industry are legally obliged to disclose APR in a contract—looking at an APR is the only way to really understand the cost of your funding and compare it to other options.

Say you’re looking at two financing options: one at a 10% interest rate and another at a 14% interest rate. Choosing the financing with the 10% interest rate is a no-brainer, right?

Well, when you really get into the contract, you see that the 10% interest rate doesn’t include what you’re paying in additional fees. You’re also paying an origination fee, an underwriting fee, and a closing fee.

That seemingly lower-cost financing might not be as cost-effective when you consider what your APR will be after you include all those additional fees.

This holds true for other types of financing, too: if you’re comparing a loan with a 12% interest rate and a merchant cash advance with a 12% payment percentage, you’ll probably think they cost about the same. But, if you do the math yourself, you’ll find out that’s typically not true at all.

How to Protect Yourself

There’s no legal requirement for online lenders to disclose your APR, but it’s the only way for you to compare apples-to-apples when it comes to business financing—and make sure you’re not overpaying.

To know what you’re really paying, ask your lender for your APR.

If they don’t disclose it, you can calculate your APR on your own, or use one of Fundera’s business loan calculators.

If the lender doesn’t want to tell you what your APR will be, take this as a sign that you shouldn’t be working with that lender in the first place. If they don’t provide transparent financing contracts and information, they’re probably trying to mislead you.

***

It’s an unfortunate reality that lenders can easily mislead borrowers in their contracts. But there are ways borrowers can protect themselves.

The bottom line? Always ask questions.

Confused about the language in your financing contract? Ask what your lenders what they really mean.

Wondering what you’ll actually have to repay when you take every fee into account? Ask for your APR, or just do the math yourself.

If you know what to look out for—and, especially, what questions to ask—you can protect yourself from being duped into a high-cost financing.  

Note: Some of these examples are particular to merchant cash advances

Editorial Note: Any opinions, analyses, reviews or recommendations expressed in this article are those of the author’s alone, and have not been reviewed, approved, or otherwise endorsed by any of these entities.
Georgia McIntyre

Georgia McIntyre

Finance Writer at Fundera
Georgia McIntyre is the resident Finance Writer at Fundera. She specializes in all things small business finance, from lending to accounting. Questions for Georgia? Comment below!
Georgia McIntyre

1 Comment

Most Recent

  • Ben Rashkovich

    Monday, August 1st, 2016

    Good tips here. Always translate interest rate into APR... Got it!

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