As banks lend less to small business owners, predatory online lending practices are on the rise
Thursday, January 26, 2017
“I was told I was receiving a $50,000 loan but the lender actually opened up 13 different credit card accounts in my name totaling $50,000, and immediately deducted “loan origination fees” from each account. I didn’t receive my first bill for three months after I had already invested what I thought was the loan amount into my business. This has killed my business credit score and the lender has yet to return any of my inquiries.”
“I was originally told after I had paid of 50% of the loan, I could receive additional capital at a lower interest rate. Once ready, I was merely told by a different customer support representative, ‘We can’t do that here.’ Due to misleading information upfront, I was unable to pay off the loan and was taken to court by the lender. There was initially no collateral promised upfront but they’ve leveraged their suit on both my business and personal assets.”
A simple search of “online predatory lending” in Google will yield many stories like the two illustrated above. The two particular horror stories above, expressed by Ohio-based entrepreneurs, are beginning to surface too commonly, as financial technology companies, dubbed “FinTech”, continue to increase at a healthy rate.
With an aim to make small business capital easier to access, as well as creating more efficiencies throughout the lending process, FinTech lenders like Kabbage, OnDeck, and Can Capital, have found a prosperous gap to fill in the small business-lending ecosystem.
Since 2004, traditional bank lending to small business owners has decreased steadily nationwide. When examining the issue locally, Ohio has seen a $590 million decrease in small business lending since 2008, giving rise to the FinTech industry. On the surface, FinTech lenders are merely taking advantage of the capitalistic opportunities their entrepreneurial customers seek out daily. However, when examining the emerging methodologies online lenders have introduced to the small business landscape, one starts to wonder if these loans benefit their borrowers in the long run.
The most notorious aspect of online lenders is that they’ve been allowed to operate in an unregulated environment, separate from their bank counterparts. Since FinTech lenders are not deemed “traditional banking entities”, national regulatory agencies such as The Federal Deposit Insurance Company are not heavily involved in regulatory practices. FinTech lenders have exacerbated the regulatory dilemma by often partnering with state-based banks where there are no interest rate caps, ensuring themselves the highest profit margins, while muddying the regulatory landscape at the national level.
With no requirement for online lenders to report annual statistics to a centralized database, reviewable information to determine the success of loans originated through FinTech lenders is scant.
The art of deceit
The rise of technology has allowed FinTech lenders greater access to entrepreneurs in desperate need of capital. By preaching innovation to solve problems in the lending landscape, entrepreneurs have put their trust (and hard-earned money) in online lenders, establishing a thriving marketplace.
On the surface, promises like “streamlined underwriting”, and “automatized loan origination and collecting processes”, are often heard as music to an entrepreneur’s ears. Navigating the day-to-day small business climate is no easy feat and when either a problem or a potential opportunity arises, access to quick capital is usually the solution. FinTech lenders are well aware of this and by offering “innovative” methodologies, granting access to capital quickly, entrepreneurs have flocked to their computers, punching in confidential business information on a keyboard with business dreams in near-sight, unaware of the potential disasters that await them.
“Streamlined underwriting” introduces new ways of determining the health of one’s business, making it easier to turn the entrepreneur into a borrowing customer. The 3 C’s (cash flow, credit score, and collateral) have been tossed aside for new proprietary methods that utilize unorthodox methods to assess how much capital a borrower can access. By utilizing social media metrics such as the amount of Facebook likes a business page receives or the amount of positive Yelp reviews one business possesses, online lenders have blurred the conventional underwriting lines, enabling them to service riskier businesses with their lending products. Since these methods are both unregulated and created by the lender, metrics can be skewed in their favor, allowing lenders to cast a wider lending net, regardless of the business owner’s actual financial standing.
Once the capital amount is determined, “automatized loan origination processes” promise more efficient procedures throughout the initial packaging of the loan, enabling the borrower to focus their energy on their business without worrying about a lengthy loan approval process. However, this paperless approach allows lenders the ability to disguise the rates promised upon the initial customer inquiry. Since online lenders are not required to disclose an all-in annual percentage rate, junk fees are carefully hidden and interest rates are often disguised through customer support conversations. Customer support representatives may quote you a 10% interest rate upfront without mentioning it as a monthly rate, creating an actual annual percentage rate of 120%. By promising the deployment of capital within 24-48 hours, Junk fees such as filing fees are often tacked on at the end of the process or incorporated into the percentage rate, without warning to the borrower.
“Automatized collecting processes” should create a lesser burden on the borrower as payment methods are automatized through the utilization of the latest technology. However, most online loan payment plans are structured by gaining access to the borrower’s business bank account and extracting payments daily. This allows the lender the automatic ability to collect, regardless of the current financial state of the business.
This lack of transparency at the onset of the loan process can rear its ugly head months after the capital has already been deployed, as one ECDI client expressed:
“It was initially advertised on the website that procedures were in place if I had to stop payment on the loan for a duration of time. Unfortunately that came to fruition and when I contacted customer support, they became very accusatory, giving me no options to stop payment. I had to actually put a hold on my bank account to self-preserve. They have since sent collectors after me.
Borrowers who are quick to realize these pitfalls and possess the ability pay off the loan in full are discouraged by costly pre-payment penalties, prolonging the debt trap for the borrower, while enabling the lender to continue to profit on false promises.
In many cases when borrowers are unable to pay back their loan, lenders have taken legal action, obtaining judgments and taking collateralized assets often times worth more than the original loan amount.
Ways to combat the problem
Practices to combat predatory lending practices have begun to take shape across the country. Just recently, New York Governor Andrew Cuomo signed a measure into state law to develop and implement an outreach campaign to educate small business owners on the online lending ecosystem.
Federal efforts made by The Office of the Comptroller of Currency (OCC) have taken a different approach by engaging with FinTech lenders directly in hopes of establishing a regulatory baseline. By offering FinTech lenders charter applications that would subject them to federal banking rules which would exempt them from certain state laws while establishing them as federally-recognized entities, The OCC hopes to see regulatory conversations at the federal level begin to take shape. However, with limited quantitative data regarding FinTech lending performance available, the FinTech industry must be a willing partner in providing information to aid the creation of proper regulatory practices, which appears unlikely.
ECDI and other federally recognized Community Development Financial Institutions (CDFI’s) are inherently designed to combat predatory lending practices by ensuring that all entrepreneurs with sound business models have access to capital to create sustainable businesses, spurring job growth at the local level. Since 2004, ECDI has deployed over $36 million to entrepreneurs across Ohio, leading to the creation of over 2,300 jobs, while retaining over 3,100 jobs. With a hands-on approach, ECDI provides ongoing business support to it’s entrepreneurs throughout the life of their loan while continually exploring new ways of enhancing Ohio’s small business climate, in hopes of creating long-lasting financial freedom for every entrepreneur that walks through their doors.
By working in unison through increased collaboration and knowledge sharing with other CDFI’s across the country, as well as small business advocates at the local level, ECDI plans to be a leader in combating online predatory through education and providing one-stop-shop small business lending services unrivaled throughout Ohio.