By Char Conger and Jake Kuschke, Entrepreneur Fund
Predatory lending has a long history in the United States and often operates under the guise of helping business owners in times of cash flow needs. During these times, business owners may feel tempted to enter a non-beneficial relationship with a predatory lending product. It is important to understand the agreements and avoid being pressured into hasty decisions.
What is predatory lending?
While there is no legal definition of predatory lending, the FDIC’s Office of Inspector General has called it, “the imposing of unfair and abusive loan terms to borrowers.” Predatory lenders utilize strategies such as excessive fees, prepayment penalties and unclear loan terms to disguise their products as helpful to borrowers.
Cautionary Example 1: A local business owner was paying $67 a day to the predatory lender.
Who are predatory lenders?
Predatory lenders target the borrower, typically when they are most vulnerable, and ignore or hinder the borrower’s ability to repay the debt. These lending tactics often try to take advantage of a borrower’s lack of understanding about loans, terms, finances, and emotional distress. Below are two common forms of predatory loans:
- Merchant Cash Advances – Many Point-of-Sale companies offer merchant cash advances as an “easy and low stress” way to gain financing. However, most of these lending options are extremely harmful to borrowers due to the lack of regulation, excessive payback amounts, and repayment methods. These products do not have interest rates, but instead charge a fee for the loan upfront and then a factor rates for repayment. In addition, repayment is often done by withdrawing a percentage of sales, which can further exacerbate the business’s long-term cash flow issues. This lack of set monthly payments makes it difficult to determine financial plans for the business.
- With Merchant Cash advances, annual percentage rates can easily be in the high double or triple digits. As cash from sales is withheld for payment, these loans can be paid off quickly with high sales numbers, however this can lead to low cash positions that presents the need to start another cash advance and restart the cycle. Typical payback figures are somewhere between 1.1 and 1.5 times the amount requested.
- Payday Loans – Payday loans typically allow a borrower to borrow against a future paycheck to receive cash sooner. A version of this also allows business owners to borrow against future receivables. These loans are typically short term and carry very high interest rates. If not paid off immediately, the interest alone can crush a business. These loans can also damage credit scores as lenders may require banking information or a postdated check for repayment within a month. If the business does not have the money, the amounts are put into collections with accuring interest.
- Typically, payday loans have regulations on the amount borrowed (ex. $500 limit), fees ($10-$30 per $100 borrowed per week), and term lengths (2-4 weeks). This means a typical annual percentage rate (APR) on a payday loan can easily exceed 200%.
Cautionary Example 2: A small boutique that used a predatory lender for inventory purposes was paying 18% of their sales each week.
What are some Predatory Lending Red Flags?
Unclear pricing and terms
- When entering into a financing agreement, it is important to understand the pricing structure and terms of the product. If these terms are hard to obtain, understand, or lacking in detail it is usually a good indication that something is off. In situations where a business owner does not understand the pricing and terms, we recommend speaking with their advisor or banker for more information.
Aggressive broker tactics
- We have all experienced uncomfortable calls with aggressive salespeople. If your lending company gives you the same feeling, trust your instincts. Predatory lending companies often use pressure tactics to close deals quickly. Take your time and carefully evaluate the options they present to you.
Approval is too easy
- If a company offers fast and easy approval with little or no required documentation or discussion with a human representative, beware. These tactics are designed to prey on business owners and to make these lending options a path of less resistance for borrowers. If a lending company isn’t doing their due diligence, how will they know that you can adequately repay the debt?
Uncommon repayment methods
- One way that predatory lenders secure clients is by offering uncommon repayment methods, such as withdrawing a percentage of sales prior to giving you cash, or having a business make small daily payments. These tactics divert attention from the total amount the business will pay on the loan. $25 per day may not seem like much, but it adds up to $750 per month.
Excessive fees or penalties
- Most predatory lending situations are not forthright with fees. They advertise these loans as easy to access cash, and then bury fees until the last possible second before a borrower signs. It is important to beware of not only the interest or payback terms, but also the fees for originating the loan. This is where lenders will advertise low or no interest loans, but really make their profit on the fees of the loan with short repayment terms.
Why do business owners get caught up in predatory lending?
Predatory lenders are hiding in plain sight. They often disguise themselves as trusted financial partners, even using well-known business and household names, making it easy to fall into their trap. Many businesses, out of pride or previous rejection from banks, hesitate to seek help from a reputable source. They sometimes feel embarrassed and desperate for immediate funds, which results in avoiding traditional lenders.
Cautionary Example 3: A local business owner had multiple payday loans and finally reached out to their Entrepreneur Fund advisor for help getting out of that cycle. The advisor calculated their interest rate and it was 200%. EFund was able to provide long-term solutions, and ultimately refinancing, saving the client thousands of dollars.
Don’t be ashamed to ask us for help. That’s what we are here for.
You never have to feel ashamed or embarrassed to reach out to us. We are your partner on your business journey and are here to help at any stage.
We may be able to offer deferrals on payments until your business stabilizes, pair you with Expert Network providers who can help move your business forward, refinance existing debt, or help find other solutions that make more financial sense for your business.
If you have questions about predatory loans or need guidance on how to deal with a current predatory loan, reach out to your advisor. Don’t have an advisor? Contact us at email@example.com for more information on how to get started with our team.
Char Conger has been a business advisor at the Entrepreneur Fund on the Iron Range since 2020 and is now EFund’s Manager of Quality Services and Programs region wide. She has over 15 years of management experience in the corporate, nonprofit, and small business sectors. Char focuses on quality job development and strategic planning to help clients reach their goals.
Jake Kuschke is an accounting advisor at the Entrepreneur Fund. He works with clients to understand accounting, bookkeeping and other financial issues and implement solutions for long-term success.