“I was told I was receiving a $50,000 loan, but the lender actually opened up 13 different credit card accounts in my name totaling $50,000, and immediately deducted “loan origination fees” from each account. I didn’t receive my first bill for three months after I had already invested what I thought was the loan amount into my business. This has killed my business credit score and the lender has yet to return any of my inquiries.”
“I was originally told [that] after I had paid off 50 percent of the loan, I could receive additional capital at a lower interest rate. Once ready, I was merely told by a different customer support representative, ‘We can’t do that here.’ Due to misleading information upfront, I was unable to pay off the loan and was taken to court by the lender. There was initially no collateral promised upfront, but they’ve leveraged their suit on both my business and personal assets.”
A simple Google search of “online predatory lending” will yield many stories like the two illustrated above. These two particular horror stories, expressed by Ohio-based entrepreneurs, and now ECDI clients, are beginning to surface too commonly, as financial technology companies, dubbed “FinTech,” continue to increase at a healthy rate.
With an aim to make small business capital easier to access, as well as create more efficiencies throughout the lending process, FinTech lenders like Kabbage, OnDeck and Can Capital, have found a prosperous gap to fill in the small business lending ecosystem.
Since 2004, traditional bank lending to small business owners has decreased steadily nationwide. When examining the issue locally, according to the Federal Financial Institutions Examination Council, Ohio has seen a $590 million decrease in small business lending since 2008, giving rise to the FinTech industry. On the surface, FinTech lenders are merely taking advantage of the capitalistic opportunities their entrepreneurial customers seek out daily. However, when examining the emerging methodologies they have introduced to the small business landscape, one starts to wonder if these loans benefit their borrowers in the long run.
The most notorious aspect of online lenders is that they’ve been allowed to operate in an unregulated environment, separate from their bank counterparts. Since FinTech lenders are not deemed “traditional banking entities,” national regulatory agencies such as The Federal Deposit Insurance Company (FDIC) are not heavily involved in regulatory practices. FinTech lenders have exacerbated the regulatory dilemma by often partnering with state-based banks where there are no interest rate caps, ensuring themselves the highest profit margins, while muddying the regulatory landscape at the national level.
With no requirement for online lenders to report annual statistics to a centralized database, reviewable information to determine the success of loans originated through FinTech lenders is scant.
The art of deceit
The rise of technology has allowed FinTech lenders greater access to entrepreneurs in desperate need of capital. By preaching innovation to solve problems in the lending landscape, entrepreneurs have put their trust (and hard-earned money) in online lenders, establishing a thriving marketplace.
On the surface, promises like “streamlined underwriting,” and “automatized loan origination and collecting processes,” are often heard as music to an entrepreneur’s ears. Navigating the day-to-day small business climate is no easy feat, and when either a problem or a potential opportunity arises, access to quick capital is usually the solution. FinTech lenders are well aware of this, and by offering “innovative” methodologies granting quick access to capital, they incentivize eager entrepreneurs to punch in confidential business information, unaware of the potential disasters that await them.
“Streamlined underwriting” introduces new ways of determining the health of one’s business, making it easier to turn the entrepreneur into a borrowing customer. The 3 C’s (cash flow, credit score, and collateral) have been tossed aside for new proprietary methods that utilize unorthodox means to assess how much capital a borrower can access. By utilizing social media metrics such as the amount of Facebook likes a business page receives or the amount of positive Yelp reviews one business possesses, online lenders have blurred the conventional underwriting lines, enabling them to service riskier businesses with their lending products. Since these methods are both unregulated and created by the lender, metrics can be skewed in their favor, allowing lenders to cast a wider lending net, regardless of the business owner’s actual financial standing.
Once the capital amount is determined, “automatized loan origination processes” promise more efficient procedures throughout the initial packaging of the loan, enabling the borrower to focus their energy on their business without worrying about a lengthy loan approval process. However, this paperless approach allows lenders the opportunity to disguise the rates promised during the initial customer inquiry. Since online lenders are not required to disclose an all-in annual percentage rate, junk fees are carefully hidden and interest rates are often disguised through customer support conversations. Customer support representatives may quote a 10 percent interest rate upfront without mentioning it as a monthly rate, creating an actual annual percentage rate of 120 percent. By promising the deployment of capital within 24-48 hours, junk fees, such as filing fees, are often tacked on at the end of the process or incorporated into the percentage rate, without warning to the borrower.
“Automatized collecting processes” should create a lesser burden on the borrower, as payment methods are automatized through the utilization of the latest technology. However, most online loan payments are processed through gaining access to the borrower’s business bank account and extracting payments daily. This allows the lender the ability to automatically collect, regardless of the current financial state of the business.
This lack of transparency at the onset of the loan process can rear its ugly head months after the capital has already been deployed, as one ECDI client expressed:
“It was initially advertised on the website that procedures were in place if I had to stop payment on the loan for a duration of time. Unfortunately that came to fruition and when I contacted customer support, they became very accusatory, giving me no options to stop payment. I had to actually put a hold on my bank account to self-preserve. They have since sent collectors after me.”
Borrowers who are quick to realize these pitfalls and possess the ability to pay off the loan in full are discouraged by costly pre-payment penalties, prolonging the debt trap for the borrower, while enabling the lender to continue to profit on false promises.
In many cases, when borrowers have been unable to pay back their loans, lenders have taken legal action, obtaining judgments and taking collateralized assets worth more than the original loan amount.
Ways to combat the problem
Practices to combat predatory lending practices have begun to take shape across the country. Just recently, New York Governor Andrew Cuomo signed a measure into state law to develop and implement an outreach campaign designed to educate small business owners about the online lending ecosystem.
Federal efforts made by The Office of the Comptroller of Currency (OCC) have taken a different approach by engaging with FinTech lenders directly in hopes of establishing a regulatory baseline. By offering FinTech lenders charter applications, which would subject them to federal banking rules and exempt them from certain state laws while establishing them as federally-recognized entities, the OCC hopes to spur regulatory conversations at the federal level. However, with limited quantitative data available regarding FinTech lending performance, the FinTech industry must be a willing partner in providing information to aid the creation of proper regulatory practices, which appears unlikely.
ECDI and other federally recognized Community Development Financial Institutions (CDFIs) are inherently designed to combat predatory lending practices by ensuring that all entrepreneurs with sound business models have the access to capital necessary to create sustainable businesses, stimulating job growth at the local level. Since 2004, ECDI has deployed over $36 million to entrepreneurs across Ohio, leading to the creation of over 2,300 jobs, while retaining over 3,100 jobs. With a hands-on approach, ECDI provides ongoing business support to its entrepreneurs throughout the life of their loans, while continually exploring new ways to enhance Ohio’s small business climate and create long-lasting financial freedom for every entrepreneur that walks through its doors.
For more information on the robust services ECDI provides small businesses and budding entrepreneurs, visit ecdi.org.