It’s National Entrepreneurship Month and one of the biggest hurdles every entrepreneur must overcome is funding their endeavors. Often an entrepreneur is faced with a choice that can be very difficult to understand and has many different potential answers when looking for small business loans. The question is, how do I avoid predatory lending?
Predatory lending typically means imposing unfair, deceptive, or abusive loan terms on borrowers. In many cases, these loans carry high fees and interest rates, strip the borrower of equity, or place a creditworthy borrower in a lower credit-rated (and more expensive) loan, all to the lender’s benefit.
The definition of predatory lending is the practice of placing unfair or unreasonable terms on borrowers.
Predatory lenders often use aggressive sales tactics and exploit borrowers’ lack of understanding of financial transactions. Through deceptive and potentially fraudulent actions often combined with a lack of transparency, they entice a borrower into taking out a loan they will not reasonably be able to pay back.
Predatory lending disproportionately affects people of color, women, the elderly, the disabled, low-income communities, and those with less education. Additionally, the COVID-19 pandemic created an opportunity for predatory lenders to take advantage of people who were economically impacted by the crisis.
The Impact Of Predatory Lending
Predatory loans are especially harmful to small businesses. While there are laws that protect individual consumers from predatory practices, unfortunately, those laws don’t apply to small businesses. Because small businesses often require more short-term funding, they are particularly vulnerable.
“An April [2021] survey of the Federal Reserve’s 12 regional banks showed only 35% of small businesses with at least one employee and annual revenue between $100,000 and $1 million had received bank funding in the past five years.”
Source: Small Companies, Big Dreams: How Predatory Lending is Destroying Small Business
“According to a survey by the Society of Human Resource Management, 52 percent of small businesses believe that they are likely to fail because of COVID-19.”
Source: Small Companies, Big Dreams: How Predatory Lending is Destroying Small Business
By 2017, the cash-advance industry had grown to a $15 billion business. While some states have banned this practice for small business loans as well as for individuals, small businesses across the country are still at risk. New York will accept confessions of judgment from any state in the country, so small business owners are often forced to sign documents allowing the lender to file in that state, no matter where their business is actually located. Since 2012, the Bloomberg investigation found that cash-advance companies have secured more than 25,000 judgments in New York. These agreements have interest rates that hover around 400%.
Family businesses, often desperate for credit and strapped for cash, are enticing targets for predatory lenders. Many businesses can be hurt by predatory lending but, it’s disproportionately small shops and restaurants owned by Black and brown Americans, and women. The biggest banks ignore these business owners, leaving them feeling they have nowhere else to turn.
Types Of Predatory Loans
Merchant Cash Advances (MCAs) are a kind of working capital loan that can be, but aren’t always, predatory. MCAs are contracts where lenders give businesses an advance on their future sales with the understanding that the advance will be repaid through a percentage of their actual sales. Terms of these contracts are often unfair to business owners, resulting in high fees and interest rates that make it difficult or impossible to repay the advance. In some cases, the merchant cash advance provider may also require personal guarantees from the business owner, putting their personal assets at risk if the business is unable to repay the advance.
Payday loans are loans that allow you to essentially borrow a portion of your paycheck in advance with the agreement that you will pay back the principal with interest on the day you get paid. These short-term loans target borrowers in dire financial need and usually involve exorbitant interest rates. Payday loans are so predatory that they have actually become illegal in parts of the U.S.
Protecting Yourself From Predatory Lending
If you’re working with an honest and professional lender, they will be explicit with you about the terms of your loan, exactly how long you have to repay, and specifically how much you will owe them. If you find yourself working with a lender who is at all vague or ambiguous about the terms and conditions of the loan, beware. Annual Percentage Rate (APR) is a helpful tool that can provide clarity to you as you compare loans.
One predatory lending practice is to require that the first year of interest be deducted from the loan upfront. For example, a business loan of $20,000 with this requirement, at a 10% interest rate, would lead to the borrower only receiving $18,000 of a $20,000 loan.
Ideally, a loan is a win for all parties involved, both the lender and the borrower. If a lender puts pressure on you to take on a loan that you don’t fully understand or even simply that you’re uncertain about, that’s a red flag. A good lender will help you understand what you’re getting into, be transparent about their fees, and work to find a solution that works best for everyone.
What To Do If You Think You Have A Predatory Loan
- You can file a complaint with the Consumer Financial Protection Bureau.
- Learn your rights. If you believe you have been coerced into a predatory lending situation, you may be the victim of a reportable crime. You may be able to sue your lender if you’re able to prove that local or federal laws were broken in the lending process. This includes the Truth in Lending Act or TILA. There’s no guarantee that you would win your lawsuit, but if you have proof, it could be worth pursuing. You will need to contact your state’s consumer protection agency to start this process.
- Contact your State Attorney’s Office
- As soon as possible, try to refinance the loan with a lower interest rate with better terms and conditions
How We Can Help
If you’re exploring your options for a small business loan, Communities Unlimited’s CDFI is built to help small business owners achieve their dreams. Please read about our mission, purpose and promise, take a look at our CDFI page and contact us if you’d like to explore your options.
Remember, transparency is key when determining whether a loan option is predatory or not. Communities Unlimited has an entire team of Entrepreneurial Experts ready to discuss your business with you.
We encourage you to read the stories of previous small businesses we’ve been involved with and contact us at [email protected] if you’re interested in learning more.
