Carolina Martinez is CEO of CAMEO, a California micro-business network, and an expert on small business and CDFIs.
Over the past four years, Darren Preston turned his Malibu’s Burgers food truck into one of the most popular restaurants in the San Francisco Bay Area. Despite lines out the door and rave reviews, Malibu’s filed for bankruptcy early last year. The cause had nothing to do with the food. What appeared to be a standard loan from an online lender turned out to be a receivables purchase agreement, a complicated arrangement loaded with hidden fees and sky-high interest rates that put Preston’s business more than $100,000 in debt.
Stories like Preston’s are common. Predatory lending has become a systemic problem for small-business owners over the past 15 years. After the Great Recession, large banks reduced their lending to small businesses, leaving a financial vacuum that has been filled by alternative lenders—many of whom exploit businesses locked out of other financing sources.
In the late 1960s, consumer credit proliferated in a similar fashion, with some banks and credit companies taking advantage of individual consumers. In response, Congress passed the Truth in Lending Act, which mandated transparent disclosures from creditors to protect individuals from exorbitant fees, sudden interest rate increases and other financial trickery.
Small-business borrowers are not privy to the same transparency requirements. The time is long overdue to pass similar truth-in-lending laws for small-business owners, bringing transparency to a financial industry that some call “the Wild West.” These laws can protect small businesses while helping ensure they can access the right-sized capital they need to thrive.
What is predatory lending?
With sleek websites, easy applications and enormous marketing budgets, alternative lenders are easy to find, especially for small businesses that have struggled to find financing at traditional banks. Easy and fast aren’t always good and often come with high interest rates and hidden fees.
One study found alternative lenders offered average annual interest rates of around 94%, with one loan reaching as high as 358%. In 2015, California’s Department of Business Oversight surveyed 14 marketplace lenders and found that a number of lenders offered the majority of their loans at annual percentage rates (APRs) ranging from 41% to 101% or higher.
Predatory lending disproportionately affects underbanked business owners who are more likely to be denied access to traditional financing. Research from the Federal Reserve Bank of Atlanta found Black and Latino business owners are about twice as likely as white business owners to apply for “higher-cost and less-transparent credit products.” Protecting small-business owners from predatory lending isn’t just about supporting entrepreneurs—it’s also a matter of equity.
How would truth in lending work?
Currently, when alternative small-business financing companies advertise their products, they aren’t required to show an APR, a trusted, recognized industry standard that most small-business owners recognize from a mortgage or a car loan. Many companies post a number that looks like an APR but isn’t, and it can result in very expensive financing. Truth-in-lending laws address this loophole by requiring lenders to clearly disclose APRs and monthly payments. This offers the same transparency that has long been available to consumers and injects fairness into the small-business financing process.
Beyond benefits to individual business owners, truth in lending would drive improvements across the small-business financing sector. When finance companies compete on an even playing field, alternative lenders will design new products that are more cost-effective and appropriate for entrepreneurs.
There’s transparency for some, but not for all.
Thankfully, some states have taken steps to implement truth-in-lending laws for small businesses. California paved the way by passing the first nationwide commercial lending disclosure law, and New York followed suit. Similar efforts are being considered in Connecticut and other states, but the pace of progress is slow. To protect all small businesses, federal legislation is necessary.
Last Congress, lawmakers failed to pass the Small Business Lending Disclosure Act of 2021, a proposal to reach businesses with the same types of common-sense transparency and lending protections already extended to individuals. If passed, projections suggest it could save small-business owners more than $4.7 billion per year. Unfortunately, the bill never moved. Congress recently reintroduced the bill, and while it is again expected to languish without passing, I’d like to urge legislators to protect small businesses.
Entrepreneurs face countless challenges when starting and scaling up their businesses; they shouldn’t have to be worried about lenders obscuring high-cost financing or imposing random fees. Truth-in-lending laws are the key to protecting entrepreneurs from predatory lending and creating a financial ecosystem that works for American businesses.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
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