As a small business owner, working capital is your lifeblood. Cash-flow management is crucial to your success, which sometimes means you need to take out a small business loan to keep the gears of your business moving. Equipment replacement, new hires, scaling your business or getting ready for a big contract are all good reasons to start looking for a loan. There are lots of funding options out there—which is both a good and a bad thing for you. It’s easy to be overwhelmed by the emails, phone calls, letters and ads from lenders. Each lender promises you the best rate, best amount, best approval rate, and awesome customer reviews!
How do you plow through it all and find the best small business loan for you?
How do you ensure that you are not getting into a trap that will extract value from your business and make the lender rich, and not you?
Unlike consumer loans, small business lenders are NOT required to display total cost of credit, APRs, early prepayment etc. This creates a muddled situation for the borrower, and it’s hard to compare apples to apples.
Big Banks have been moving away from small business lending for several years. This has enabled multiple online lenders that use deceptive marketing practices and even predatory lending practices.
Here are 5 most important things that you need to review before you sign for your business loan.
- The Total Cost of the Loan (interest rates and all the fees): Sometimes the true cost of a loan is not clear. To keep you from spending more than you anticipate, ask your lender about all the costs involved including all the interest, origination fees, servicing fees, guarantee fees, etc. Make sure your lender shows you the full APR (Annualized percentage Rate) on your loan irrespective of whether it’s for short-term financing or a merchant cash advance or any other small business financing product. We’ve seen lenders quote an “interest rate” of 5% or 9%, when the actual APR was 50% to 80%! APR is the metric that you can use across multiple loan choices to pick the cheapest one. If you’re not sure what your true APR is, use an online APR calculator, such as the ones available here). Be wary of short-term loans without interest rates. Low interest rates with shorter terms often mean you end up paying way more through fees.
- Early Prepayment Penalty: Yes, you read that right. Most online lenders have a penalty to pay off your loan early. Many online lenders will actually charge the whole interest due over the lifetime of the loan irrespective of when you pay it off. This is called interest acceleration, and it’s the lenders way of making sure they make the interest they expected on the loan…even if you pay it off early. This is a hidden trap and lot of small business owners fall for this. It is often buried in the legalese, and you don’t realize the penalty unless you want to prepay your loan early. Imagine not being able to refinance your loan. Imagine not being able to transfer your credit card balance to a lower rate card. This is what a prepayment penalty does. Don’t be fooled by a so-called “discount” on the early prepayment fees either. For example, one of the most popular small business lenders online touts a “25% discount” on prepayment. What this really means is that you are stuck paying ONLY 75% of all remaining interest over the lifetime of the loan, even if you pay it off early. Some discount!
- The Track Record and Practices of the Lender (payment frequency, early payment penalty): How do they want you to pay back the loan? Is it a fixed daily, weekly, or monthly payment, or is the payment a fixed percentage of your sales or credit card receivable? Always look at the customer feedback on third-party websites NOT just on the lender websites. Check out their reviews on the Better Business Bureau (BBB) or social media sites to see what customers have said about them and how they resolve customer complaints.
- The Requirements of the Lender (personal guarantee, security): In order to secure funding, lenders have certain requirements to ensure you pay back the loan in full. Do they require a personal guarantee? Having a guarantor on a loan is a standard industry practice and shouldn’t affect you personally if you are able to pay the loan back on time. Is the loan secured? If your loan is secured through a blanket lien or specific lien on your assets (such as your car, house, or equipment), it can lower your borrowing costs and help you get a larger loan amount but in case of default the lender may come after your assets.
- Double dipping: When borrowers take out new loans before fully repaying an existing loan (i.e. refinancing existing debt), they are often double-charged the origination fees for the outstanding portion of their loans and hence end up paying double fees on the first loan. It’s like filling your gas tank when it’s half full put paying for the whole tank of gas. No thank you!
Knowing the answers to these questions will ensure that you are making the right choice and avoid the classic debt traps.
Please “think before you ink.”
Madhur Grover is Chief Credit Officer at StreetShares. Madhur previously worked at Capital One for 10 years and is a CFA charterholder.
StreetShares is America’s small business funding community. Business owners get fast, affordable small business loans and meet investors and backers who support their business. Investors earn solid returns and back businesses they believe in. Membership is free and open to qualified small businesses and investors. StreetShares is veteran-run and located outside of Washington, D.C. Learn more at StreetShares.com.