Borrowers are having trouble comparing rates for online small-business loans and want a more straightforward explanation of the costs to make a better-informed borrowing decision, according to a recent study conducted by the Federal Reserve Bank of Cleveland and the Federal Reserve Board.
The study interviewed 44 small-business owners across a wide range of industries with two to 20 employees and less than $2 million in annual revenue.
“Participants in the study expressed uncertainty or answered questions incorrectly when making specific product comparison, particularly on cost, ” wrote Barbara J. Lipman and Ann Marie Wiersch, the authors of the study.
Borrowers want to see APR
Participants suggested that interest rates be expressed as an annual percentage rate, which represents the true annual cost of borrowing with all fees included. APR is a standard method of expressing the costs of credit cards, personal loans, car loans and mortgages.
Borrowers also asked for a clearer explanation of fees, such as late fees, origination fees and prepayment penalties.
“The lack of standardization in how online lenders present their products was problematic for many focus group participants, ” the study found.
The issue: Only a few online lenders express their loan costs as APR. For example, OnDeck, which provides term loans of $5, 000 to $250, 000, explains the cost of those loans on the basis of cents paid per dollar borrowed. On the typical $25, 000, six-month term loan, borrowers pay 17 cents for every $1 borrowed on average, according to the company. OnDeck’s APR for its term loans range from 16% to 98%, although its rates have fallen over time. (Here’s why.)
Kabbage expresses its loan costs as a total fee amount paid over six months; its APR is 20% to 113%. Invoice financing company Fundbox does not include APR in its pricing explanation, simply listing the total fees you’d pay over a period of one to 12 weeks (44% to 64% APR). Funding Circle expresses its loan costs as a fixed-interest rate but doesn’t include origination fees in the calculation (7% to 26% APR).
“The effective interest rate expressed as an APR could make comparing products easier, especially alternative credit products with traditional ones, ” Lipman and Wiersch wrote.
Small-business borrowers say it’s tough to size up products
Participants also expressed confusion when making specific product comparisons.
The authors gave one example of a product meant to represent a merchant cash advance, which is an infusion of cash in return for a portion of future credit and debit card sales: $40, 000 is borrowed and $52, 000 due, repaid by taking 10% of the businesses’ debit and credit card sales each day, until the full $52, 000 is repaid.
When asked what they thought the APR was on this product, the answers ranged from just 5%, to 50%. In this case, the APR on this product is impossible to calculate, as it depends on your monthly sales volume and how long it takes to repay the $52, 000 in full.
If your sales skyrocket and the loan is repaid faster, the APR on this product actually rises, since the entire $52, 000 is still owed, regardless of how early it is repaid. MCAs typically cost anywhere from 70% to 350% APR, and should generally be avoided unless you have no other alternatives.
“Perhaps not surprisingly, the lack of details about early repayment on this product was a source of confusion for many participants, ” Lipman and Wiersch wrote.
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