Alternative lenders are moving further toward the mainstream.
Last month alternative lender OnDeck announced a partnership in which JPMorgan Chase will use OnDeck's technology to underwrite credit to some of the giant bank's 4 million small business customers. In October, online lender Biz2Credit inked a similar deal with Customers Bank. Also that month, online lender Fundation began working with Regions Bank to offer its loans to the bank's small business owner customers.
The partnerships are a significant development for the alternative lending industry, which has been looking for an imprimatur of acceptability to widen its customer base. They're also a potentially important move for banks, which have been criticized for moving too slowly to provide credit to small businesses in the wake of the financial crisis.
There are approximately 200 alternative lenders in the U.S., according to financial services research firm Barlow Research Associates, roughly half of which are dedicated exclusively to business loans. Typically these companies offer loans of between $10,000 and $100,000 through a quick online signup and credit underwriting process that uses nontraditional scoring sources. The entire process can be completed in minutes, and funds can show up in small business bank accounts within hours rather than days or weeks. On the downside, these lenders may have higher interest rates and more onerous repayment terms than traditional financial institutions charge.
While alternative lenders make up just a fraction of lending to businesses, expect deals like OnDeck's with Chase to become commonplace, financial experts say. But while you are likely to benefit from the expanded credit opportunities offered to your small business as a result of these deals, you need to proceed with caution: Such loans may carry more risk than standard bank commercial loans. Below are three things to pay attention to.
1. Rates and Fees
Alternative lenders tend to charge much higher interest rates than banks do--sometimes on the order of 50 percent annual percentage rates or more. They also charge origination fees. (OnDeck, for example, has an origination fee of 2.5 percent of the principle for its loans.) While banks aren't likely to charge rates that high for the loans originated through their partnerships, the rates are likely to be higher than what they offer for more traditional commercial loans, some financial experts say. "When it comes to small business loans, banks do not have to play by the same rules, so (many) consumer protections are not available to small business owners," says Christine Pratt, a senior analyst for Aite Group, a financial services research company. Limits on interest rates are one of those protections, she adds, so make sure you understand the rate you're being offered.
2. Repayment Criteria
Many online lenders require daily repayments, which are taken directly from your business checking account. That's a far cry from the monthly payments that most business owners are accustomed to making for other types of financing, and for some entrepreneurs the daily debits could pose a cash flow problem. Banks are likely to test various repayment options for loans made through their new partnerships, but be absolutely certain you're aware of the requirements.
3. Know who owns the loan
While some banks are testing small business loan offers through partnerships that allow them to use the technology of alternative lenders, in some instances banks may refer you to an alternative lender itself. Wells Fargo, for example, refers some small business clients that reportedly don't qualify for its traditional bank credit to CAN Capital. (Wells Fargo would not comment on particulars of its arrangement with CAN.) And not all alternative lenders are structured the same way. Roughly half of the 112 online lenders that make business loans are direct lenders, according to Barlow, which means they hold the loans on their own books. The remainder source loans for banks and other investors. While the ownership structure of the loans should not affect the terms you're offered, it could affect the way the loan is serviced, including the customer service you receive.