Recently, one of our borrowers informed us that they had applied for an online direct loan with one of the major companies involved in this growing industry, which analysts say has doubled in size each year since the 2008 recession. Per requirement of our loan documents, our client notified us that they were searching for a quick, direct loan. The whole process was a great learning experience for both parties. VCF felt it was our obligation to our customer to understand their logic and reasoning.
Our initial questions were “Why?” and “For how Much?” Our client was looking for about $50,000 for a specific expense, and they had decided to go with this new online lender because they felt that it would be quick and the rate wasn’t so bad. VCF believed the client did not fully understand the offer, but allowed them to proceed with the application so we could teach our customer the full cost of the loan before accepting the offer.
The website quoted interest rates “…as low as 12%, depending on credit approval”. The application process was extremely easy and the client could complete the entire process online. Loan approval was granted the next day, with our client qualifying for the lowest interest rate offered, 12%. The loan request was for $50,000, and the client wanted to pay it back over 12 months, which was also granted.
Since these direct loans are to businesses, not individuals, the lender is allowed to quote and charge interest differently than with a consumer loan. The 12% rate quoted and charged was not the Annual Percentage Rate (APR) most of us are accustomed to seeing when interest rates are advertised and quoted. Rather, it was an upfront fee that the lender deducted when funding the loan. Thus, when the loan was funded, our client did not receive the full $50,000. Instead they received $50,000 minus the 12% interest, resulting in an actual total loan of $44,000. This effectively provided the online lender with its entire fee on the front-end of this transaction. Heaven forbid you wanted to pay the loan off early!
Our client’s loan was structured such that the lender automatically deducted $846.15 from our client’s bank account every Monday. This means that the average balance on the loan over the course of the 12 months was not $50,000, or even $44,000. The average balance over the 12 month period of the loan was actually only $22,000.
In this case, the APR is calculated by dividing the $6,000 interest by the $22,000 average balance outstanding. Thus our client paid an annual percentage rate of 27.27% for a loan they believed was priced at 12%.
Applying for the online loan was very easy and the lender’s approval decision came quickly. The payment process was simple. However, the pricing advertised did not match what the borrower thought they were paying for.
A recent article posted by the Federal Reserve Bank of Cleveland stated that these loans are faster and easier than other alternatives, and that more small businesses are applying for them than ever before. The convenience cannot be argued, although according to the study, these loans “..can carry effective interest rates—often undisclosed—of 25 to 150 percent.”
From a business perspective, there may be times when one of these loans is the right solution, but as an informed business owner, make sure you have all the facts and a full understanding of the true underlying costs before you sign on the dotted line.