Entrepreneurs wanting to get a small business off the ground may be intimidated by getting a traditional bank loan. The time involved, the hoops to jump through, the paperwork, the approval process — that’s a big mountain to climb.
So many are turning to online lenders. Some of these upstart companies boast they can offer a line of credit “within minutes.”
Is online lending the right choice for a prospective new business owner? Could be, but there are steps to examine, including how the interest rate compares to a bank loan.
Here’s a look at some of the different sides of this fast-moving trend.
Cause and effect
The difficulties involved with getting a bank loan — and getting it quickly — are a prime reason for the online-lending boom, according to Brock Blake, writer for Forbes.
“The current small business-lending infrastructure is inefficient,” writes Blake. “There is capital to lend, there is demand, but the way traditional lenders connect with borrowers is inefficient. Regulation doesn’t make it easy by any means and the last few tough years for small business has risk-averse bankers hesitant to stick their necks out. What’s more, most bankers aren’t really interested in any real innovation in small business lending.”
How widespread is it?
We may hear about new online lenders popping up all the time, but how much influence do these companies have? A story in Forbes by Alicia Robb and Dane Stangler of The Ewing Marion Kauffman Foundation references a survey by four regional Federal Reserve banks, which reports that more than 20 percent of “young companies” went through online lenders for credit in the first six months of 2014. The authors note, “Considering that this market was nonexistent not too long ago, that is impressive.”
Brayden McCarthy, former senior policy advisor at the White House National Economic Council and the Small Business Administration, wrote a piece titled “We Need a Small Business Borrowers’ Bill of Rights.” In it, he details how the lack of regulation has allowed online lenders to flourish, and warns of potential dangers.
“Online lenders are subject to far less oversight than banks,” writes McCarthy. “Without one unified federal regulator, most players are governed by a tattered patchwork of state-based rules. That’s made it easier for predatory players to intervene. … About half of loans from prominent online lenders are funneled through offline loan brokers, many of whom promise to help borrowers find a customized loan but instead steer them toward loans where the broker earns the highest fees. And they do this entirely unbeknownst to the borrower. Moreover, some lenders deliberately obfuscate the loan’s total cost, refusing to disclose an APR, interest rate, or tools like loan calculators for any product, making it harder for borrowers to comparison shop.”
A complement, not a replacement
The buzz over alternative lenders may cause some small business owners to think they will soon replace the banks. Tap the brakes on that, Scott Shane says in a story for smallbiztrends.com.
“Rather than substituting for bank loans, online lenders are filling a niche, providing capital primarily to small companies that previously had been unable to borrow,” writes Shane. “Online lenders aren’t replacing banks as a source of small business credit because their main advantages to borrowers (faster loan decisions and greater odds of getting credit) come at a cost — much higher rates of interest. Estimates by Federal Reserve researchers show that the interest rate on the average online small business loan is more than twice that of the average traditional bank loan.”