Predatory Lending: How Do I Know if My Small Business Loan Officer is Legitimate?
May 29, 2019 | Last Updated on: July 18, 2022
May 29, 2019 | Last Updated on: July 18, 2022
Predatory lending is a growing problem for small businesses. Whenever a lender is looking to protect their needs over the needs of their customers, they are engaging in predatory practices. Many companies take advantage of first-time business owners, women business owners, and minority business owners, who may be less familiar with entrepreneurship. Some laws allow companies to engage in predatory lending with little penalty.
Predatory lenders are easy to spot, as they generally engage in the same practices. If your lender waves one or more of the following red flags, you should keep an eye out for loan scams.
One crucial piece of advice up front: A legitimate loan broker will never, ever ask you for money up front.
A reputable loan officer will provide a borrower with everything they need in order to make a good decision. predatory lending usually involves hiding or disguising facts. They should give you the interest rate and the payment terms, and let you know about any penalties you may incur for early payment. A loan broker should make very clear whether the loan includes a balloon payment.
Predatory lenders encourage borrowers to “let them worry about the details,” even though the borrower’s credit, business, and livelihood are tied to managing those details.
Fraudulent lenders prey on borrowers who might not understand contracts, or might need the money so desperately that they rush through the process and place their trust in a professional. Hiding details is a red flag that your lender is hiding something from you.
Speaking of omitting information, a legitimate commercial loan operation will have a physical address — not just a P.O. box. Even online lenders will include their address in their contact information.
Small business owners must provide a lot of detailed information in order to qualify for a loan. A reputable lender will ask for financial statements from the business, income projections, and will run a personal credit check as well as look into your business’s credit history. These documents help the lender figure out if you will be able to pay back the loan on time and in full.
If your loan officer doesn’t require this documentation, and tells you that bad credit doesn’t matter, they likely have a financial incentive tied to your failure to pay. Bad credit loans are actually more difficult to secure, as they need more documentation to convince a lender to take a risk on someone who hasn’t been responsible in the past.
Be aware of any loan broker who says “no paperwork” or “easy approval,” without making their approval process transparent.
Certain merchant cash advance products are designed to exploit inexperienced borrowers — often women, minorities, and immigrants — as these communities typically have less exposure to business lending and legal processes. Like a credit card cash advance, merchant cash advances provide a borrower with a lump sum of cash, which gets paid back when customers buy your services. However, because a cash advance is not technically a loan, it isn’t subject to the same regulations as an actual loan, which makes it an attractive instrument for a scammer. What may look like a good deal may end up having an astronomical interest rate, so merchant cash advances are a place to tread carefully — do extra research on the lender.
There are some legitimate lenders that offer merchant cash advances, especially credit card payment processing companies that are expanding their own businesses to include lending. Different lenders will have different approaches to MCAs.
Refinancing a loan can be a good thing. Typically, a borrower will refinance an existing loan for a lower interest rate, more relaxed payment penalties, or lower monthly payments.
However, some predatory lenders coerce their clients into rolling their existing loan into a new product with higher interest rates. This is called loan flipping, and it lures borrowers with a promise of an early cash payment, which is typical in a refinancing scenario. It becomes loan flipping when that cash payment is accompanied by loan terms that are less favorable for the borrower: balloon payments, increased penalties, and increased fees.
Though obtaining a legitimate small business loan may seem complicated, there are many resources designed to help first-time borrowers make the best decisions.
Lawmakers have set their sights on predatory small business lenders, noting that small businesses have become the latest target for loan scammers. In December 2018, US representatives sponsored the Small Business Lending Fairness Act. This law will make confessions of judgement completely illegal, closing the legal loophole that allowed the practice in commercial lending. When it goes into effect, lenders may no longer use it as a binding contract, and won’t be able to touch a lender’s assets.
Other than the government, there are several groups dedicated to helping small business owners obtain business capital.
A great resources for loans and information is US Accion, a non-profit community lender that provides small business loans, but also provides other resources to make sure entrepreneurs are making the best decisions. Their mission is to help minority, women and low-income businesses succeed, and a major portion of their clients are from these underrepresented groups. They also offer specialized loan products for veterans, people with disabilities, and business types like salons and restaurants.
The US Small Business Administration also sponsors a loan program that is available from pre-authorized community lenders. Some funds from SBA loans are restricted to certain business practices, such as buying land, property and durable equipment. There are also SBA loan types specifically for minority-owned and women owned-business, and these funds have fewer restrictions on usage.
Overall, doing all of your research into a lender, and into the legal and financial issues of your industry, will make you the best loan consumer, and will help you find a reputable funding source that suits all of your needs.