Michael Medina, Loan Consultant at Accion East, gives us tips and tricks to protect your small business from fraud, predatory lenders, and scams. It’s an important topic in 2020 because due to the rising prevalence of predatory lenders, plus an increase in scammers falsely posing as SBA lenders that are targeting small businesses seeking capital to survive the COVID-19 shutdown.
Medina says that with the upsurge of internet banking, there has been an increase in alternative financing and a variety of new lenders and loan types available electronically as well. Before applying with any lender, do your research and read the fine print to fully understand the terms offered, as each lender is different.
If you’re turned down for loans from mainstream commercial banks or credit unions, you are then faced with a range of options with terms that can vary widely from fairly inexpensive capital from a trusted microlender such as Accion for example to outrageous loan terms that are considered predatory.
Medina says when it comes to online lending for small businesses, the industry is far less regulated than mortgages and car loans. This has led to some absolutely shocking practices that are technically legal but can financially destroy your business. Medina says that is why it’s critical to carefully run the numbers and be meticulous in your math to figure out exactly how expensive a loan is before agreeing to any terms.
Medina says when making the decision about what kind of business funding to apply for, to remember the old axiom, “If it sounds too good to be true, it probably is.”
Types of Loans to Avoid
Medina says that generally speaking, a traditional bank loan is a safe bet. Loans to look out for and avoid are payday loans where you borrow against a paycheck and car title loans where you borrow against the title for your car. Payday loans and car title loans generally carry an extremely high annual percentage rate (APR) or interest rate and can trap you in a cycle of debt. Medina says a tax refund anticipation loan is a short-term cash advance and they also have exceptionally high APRs.
Medina says the sad part is that payday loans and other predatory lenders often drain cash away from low-to-moderate income businesses and communities. They often provide false information or they withhold information to hide their high-interest rates. So it’s important to be an educated borrower to avoid falling for these scams.
These so-called “alternative lenders” can be especially problematic because they fall outside the regulations that traditional banks must abide by. Funds from these alternative lenders can range from business loans to cash advances, lines of credit, and personal loans. Your payments include interest and fees like most common loans, but unless you look closely, you may not realize that your APR can easily top 500%. That extra zero is not a typo!
What Is Predatory Lending?
According to Debt.org, “Predatory lending is any lending practice that imposes unfair or abusive loan terms on a borrower. It is also any practice that convinces a borrower to accept unfair terms through deceptive, coercive, exploitive, or unscrupulous actions for a loan that a borrower doesn’t need, doesn’t want, or can’t afford.”
Many small business owners are being approached by lending companies offering fast cash. This is one of those “too good to be true” claims you want to be cautious about. When it comes to companies that are not regulated and bound by state treasury laws, the loans they offer are typically full of hidden fees and fluctuating payment schedules. These daily or weekly payment schedules strip business owners of the cash they need to operate. When evaluating a loan, Medina says to check to see if there are administrative fees attached to each payment.
Medina says predatory lending practices can include:
- Inadequate or false disclosure of loan terms and payment schedules
- Risk-based pricing
- Abnormal prepayment penalties
- Inflated and hidden fees and charges
- Complicated terms that make it difficult to calculate the APR and true cost of the loan
- Loan contracts making it illegal for a borrower to take legal action for fraud or misrepresentation
These loans are often marketed toward individuals who don’t have legitimate loan alternatives. This might include low-income individuals or people with a poor credit score.
When evaluating a loan, you want to look for traditional terms such as a monthly payment schedule and easily understandable terms and APR. When it comes to daily or weekly payments, Medina says to proceed with extreme caution and it’s probably best to avoid such a loan because it can hurt the future of your business.
If a lender is not upfront about the total cost of the loan, that is a sign of a predatory lender. You want to know right upfront the cost of the capital you’d receive, including the interest rate and all fees. Medina says to do the math on your own, and not to take the numbers given at face value. Include principle plus fees and interest when applying for a loan. The problem with a predatory lender is that they might not even disclose all of the fees they plan on charging you. Always research a company and see what results from other people have had before proceeding with a borrower.
Is the Interest Rate Annual, Monthly, or Daily?
Many predatory lenders will charge you a daily or monthly interest rate instead of annual rates. You should understand how this can affect you in the long run.
For an easy-to-understand example, let’s compare a 10% yearly interest rate versus 1% interest monthly. One percent per month sounds like a more favorable interest rate than 12% per year, right? Think again! If you calculate 1% multiplied by 12 months, you get a 12% annualized interest rate. So in this case, a 10% annual interest rate is a more favorable loan term than a 1% monthly rate. But when we see the lower monthly rate advertised without doing the math, it can be easy to be fooled into a misunderstanding of the actual annual interest rate.
Medina says there are some predatory loans where you accrue interest charges daily or weekly, and this is how these predatory loans can achieve astronomical interest rates with misleading advertising. It’s important to know and understand the annual interest rate, including all fees. If all of the loan terms aren’t crystal clear to you, don’t sign!
How Much Time Do I Have to Repay the Loan and How Frequent Are the Payments?
Predatory lenders tend to offer short-term loans. Look for abnormal payment structures, which you want to avoid. Single monthly payments are desirable. Are the payments debited daily or weekly, or as a percentage of sales? Are there administrative fees attached to each payment? These are all terms to avoid; daily, weekly or a percentage of sales can come at a high cost to your business.
Are there pre-payment penalties? You want to avoid a loan that includes penalties for paying back the loan early. Lenders make money when they charge interest on loans, so some unscrupulous lenders will want to take away your right to pay off the loan early. Your incentive is to pay off the loan early to save money on interest, while a predatory lender’s incentive is to discourage early pay-off or refinancing so you are forced to pay as much interest as possible. A lender that is trustworthy will allow early loan payback or a refinancing of your loan to a lower interest rate if that option becomes available to you; avoid loans that have terms that do not allow for this or that charge a large fee to refinance or get out of the loan early.
Predatory lenders are betting you won’t be able to pay the loan back on time or within the agreed-upon terms, so you’ll need to borrow more money to repay the loan. This way you get caught up in a cycle of debt as you accumulate more interest and fees that you’ll be unable to pay back. Predatory lenders will drain your business of capital until there is nothing left for them to take, and your business is destroyed. Since these lenders fall outside of regulations, you don’t have the legal protection or recourse to help you out of the situation.
How Quickly Will You Receive the Money?
While it may seem tempting, quick, and easy approval for a loan with little or no required documentation may result in a high cost to you and your small business. Less examination of your financials by the financial institution means a higher risk to the lender, which comes with higher interest and fees for you. A lender that forgoes a credit check before offering you a loan does not assess how you’ve handled debt in the past or the potential impact to your business of taking on more debt. A Pew study found that only 14% of payday loan borrowers can afford to repay their loan.
Reputable microlenders such as Accion who loan money to small businesses have a thorough application process. This means assessing the viability of your business to make sure the loan will not negatively impact the health and success of your business.
How Accessible and Helpful Is Customer Service?
It’s important that you’re able to easily reach out and contact your lender to assess the total cost of capital, which you should do before accepting the terms of any loan you’re offered. In reaching out, here are some red flags to make note of and avoid:
- It’s difficult to reach an individual. You should be able to easily contact your financial institution and speak to a human on the phone.
- You get unclear guidance or elusive answers. You should be able to easily get clear, helpful, easy-to-understand, and truthful answers.
- There’s a lack of transparency or confusion. Never be afraid to ask questions and build trust.
- You are subjected to aggressive marketing of additional debt, loans, lines of credit, or products like insurance.
You want to feel safe in knowing you can provide your private financial information and social security number to a trustworthy, reputable business. Always look up reviews of any financial institution you are thinking of doing business with, and make sure you are seeing real reviews from real people.
How to Spot a Scammer Posing as the Small Business Administration (SBA)
The SBA is a trustworthy and reputable organization that seeks to help and serve small businesses. However, there are predatory lenders and other fraudsters who would abuse the good name of the SBA to conduct a scam. The SBA is offering a number of financial relief programs for small business owners and the SBA is reporting there are scammers using their name to defraud small business owners.
To protect yourself against such scams, the SBA says to remember the following facts:
- The SBA will not reach out to you advertising any of their programs.
- Be wary of unsolicited telephone calls and emails from individuals claiming to be IRS or Treasury employees. Remember the IRS’s first line of communication is via postal mail, not by phone or email.
- If you are contacted by someone promising to get an approval of an SBA loan, and they require any payment upfront or they offer a high-interest bridge loan in the interim, suspect fraud.
- There is no cost for applying, downloading, or accessing SBA forms and papers.
- Do not provide your credit card information; the SBA does not require it.
Reported scams have involved letters, emails, or calls:
- Offering assistance to process SBA applications or loans and promising approval for a fee
- Asking for credit card information
- Asking for the name of the bank and account number where your stimulus check can be deposited into
- Asking you to install software or another app disguised as malware onto your computer or device
How Can You Avoid Small Business Scams?
Always cross-reference any information you receive with information available at SBA.gov. Look out for phishing scams utilizing the SBA logo. The presence of the SBA logo on a webpage does not guarantee the information is accurate or endorsed by the SBA. Check the sender’s information. Any email communications from the SBA will come from accounts ending with SBA.gov. But again, they will not contact you directly first. You would only receive communication from them if you reach out first.
Conclusion: Tips to Remember to Avoid Scams
Take your initial request for funding to a traditional bank, local credit union, or trusted microlender such as Accion. When in doubt about an organization, talk to trusted financial professionals to help you assess a situation before accepting a loan.
Beware of unsolicited or overpromising offers. Faster is not always better. Don’t rush the loan application process or go for a quick cash payout with unfavorable terms. Take the time to fully understand the fees and interest rates. If offered additional services or assessed a prepayment penalty, take a step back to further evaluate the company you’re talking to. It’s always important to research and read reviews of any financial company you’re considering accepting a loan from.
A snap decision on your part to take out a bad loan can kill your business in the long run. Think long term, properly assess the effects of taking out the loan, use your best judgement, and protect yourself from scams.