If you’re an entrepreneur looking to borrow money to grow your business, applying for small business funding might dampen your excitement. Bank business loan applications are tedious, tiring, and cumbersome, but the more convenient online business loans cost more.
Why the difference? Here’s what you need to know.
Online business loans from alternative lenders cost more for borrowers because they cost more for lenders, too. Banks simply have access to cheaper money from a couple of different sources.
First, there are the bank’s deposits. You know those savings accounts the banks offer? They’re used to make personal and business loans. Banks have quick, easy, and cheap access to customer’s deposits.
Second, the banks’ bank (otherwise known as the Federal Reserve) loans money to banks at lower rates than alternative lenders are getting from their credit facilities. The money that alternative lenders offer to small business borrowers comes from investors like venture capital firms, hedge funds, and sometimes even individuals looking for a better return on their dollar.
One of the main reasons getting a business loan online instead of through a bank costs more is that many alternative lenders offer loans to business clients normally considered “high risk.” To take on this higher risk of losing the money they’re loaning, alternative lenders charge higher interest rates. Instead of playing it safe, like the banks do, alternative lenders take bigger risks—so they need a bigger cushion in case things don’t work out.
Bank lending tends to focus on businesses that have been operating for at least ten years, according to a recent Wall Street Journal article. Younger businesses, including startups, find it very difficult to even qualify for a traditional bank small business loan. New businesses without several years of financial statements and revenue documentation usually get the “high risk” label, simply because they don’t have a business repayment record.
But increasing numbers of alternative lenders offer startup loans that don’t ask for much, if any, business credit history to qualify. In these cases, your personal credit history is more closely scrutinized, and you should expect to pay a higher rate. Startups and fledgling businesses might qualify for working capital loans, equipment loans, lines of credit from LenCred, professional practice loans, and franchise startup loans through alternative lenders.
Another reason online business loans cost more: alternative lenders offer loans to business clients with less-than-stellar credit scores—a group that traditional banks shy away from, as they’re expected to have a higher risk of loan default. By evaluating a variety of financial factors, like your business’s revenue record and cash flow statement, alternative lenders might choose to take on this risk—but at a premium interest rate.
In most cases, getting an online business loan is much faster than getting one through a bank. You complete your application by filling out one or more online forms—and depending on your lender, you might be able to save more time by prepopulating your form with information from your financial software.
Loans through alternative lenders could get approved in under 24 hours, and many lenders now say loan funds will be available in as little as two days.
From start to finish, the process is much quicker than trying to get a business loan through a bank. However, this quick processing time results in the lender dealing with higher processing costs, which are then passed onto the borrowers.
Alternative lenders give you the opportunity to apply for a business loan from your home or office computer, while very few banks can provide that level of convenience. This saves the time and hassle of traveling to the bank and meeting with a small business banker at least twice—once to go through the loan application, and then to sign documents and receive your funds once the loan arrives (if you’re lucky).
Alternative lenders offering automated online business loans often use special algorithms to approve applications and make rate decisions—which can be very convenient for borrowers. Bank business loan approvals often require underwriting (or review of all financial statements, credit reports, and loan applications) from a team at a head office, or at least a different department. In some cases, this process might lead to more questions and require you to provide additional supporting documentation, adding to your inconvenience as well as delaying the receipt of your funds.
Though online business loans comes with higher interest rates than bank business loans, speed, convenience, and their willingness to lend to higher risk borrowers make them a practical solution for many.