The cost of alternative lending
Alternative and online lenders are promising small business owners looking for funds, quick and easy access to capital. With the hype surrounding these loans, it would seem that alternative lenders are giving away free money. But that is most certainly not the case. So what are these loans? Where do they come from? Let’s break it down.
Rise of the alternatives
The financial crisis in 2008 had a severe impact on small business owners and the traditional lenders that they relied on to fund their businesses. According to a paper from the Harvard Business School, data from the FDIC suggests small business loans are down 20 percent since the recession. Banks, looking to minimize risk when working towards recovery, may be less likely to approve risky, less profitable small business loans.
Recognizing a potential gap in small business lending, alternative and online lenders have become ubiquitous. They promise fast cash to businesses looking for funding. Alternative lenders do not account for a large percentage of small business lending, but it is growing rapidly. A 2015 report from the National Small Business Association reported an increase from 1% to 2% of small businesses obtaining a loan from an “online or non-bank lender” from December 2014 to July 2015.
The Truth in Lending
Operating outside of the heavily regulated world of banking, the practices and prices of these alternative lenders varies wildly and are difficult to pin down. Alternative lenders do not have to comply with federal regulations, such as the Truth in Lending Act, that are in place to protect borrowers from unfair lending practices. Banks are required by law to report the APR (annual percentage rate) for all loans, something that alternative lenders do not.
This lack of regulation allows alternative lenders to mask the actual cost of their loans to borrowers. The cost of these loans can fluctuate. Small business owners can sometimes pay up to 50 percent, according to the New York Times. In a study from the Cleveland Federal Reserve, a survey of small business owners revealed that they were drawn to the ease and speed of alternative lenders, but found it difficult to determine the actual cost of loans.
Borrower beware?
With the alternative lending business growing exponentially, what should small business owners consider an online lender when looking for capital? The answer is there is no blanket answer that can possibly cover all of the products that can be considered an “alternative loan.”
Clearly there is a market for alternative and online lenders, and that cannot be ignored. Borrowers are drawn to the quick capital and user-friendly experience provided by these lenders to fund their business.
The industry is changing rapidly, with more regulation on the way for alternative lenders. Regulation shouldn’t disrupt innovation, but innovation can’t come at the cost of hurting small business owners. The future of the industry is in flux, so borrowers should always be wary of a deal that sounds too good to be true.
