The Dangers of Predatory Lending
It starts with a phone call or a friendly letter. What comes after can destroy a business.
Predatory lending offers are designed to look friendly and appealing and show no external warning signs of the danger that comes when the contract is signed, David Rogers, president of Auto Profit Masters, explains. According to an article by the Consumerist, nearly one in four consumers turn to high-cost options, such as predatory lending, to make ends meet.
Rogers recalls an instance where a shop owner he knew fell for a phone call from a business lender that offered financial flexibility. What the shop owner didn’t fully understand was the way the lenders would collect payment. The deal was that the owner wouldn’t have to make regular payments to the lender, but instead would take a share of every sale the shop made, sometimes in excess of 12 percent.
“The 12 percent they take out of every ticket is your net profit,” Rogers says. “That means the owner doesn’t get to take a payment for two, three, even four years. That’s four years of not being able to make house payments unless you take from the business.”
Rogers explains that the only way for these owners to take a paycheck is to withhold payments from another aspect of the business.
“By that point, the owner quickly loses everything,” Rogers says. “There’s no way out. The more money the business makes, the more the lenders take.”
“I’ve seen three shop owners in three different states hurt by these kinds of predatory lending companies,” says Rodgers, who also co-owns a shop in Colorado. “All three came close to losing everything, and all three were in that position before they even realized what was happening.”
Defining predatory lending
Charles Grice, managing director at CRI Compliance, a company that advises borrowers and lenders, says that there is no clear definition to what exactly defines a predatory loan throughout the country; a high interest rate might be considered predatory in one area and fine in another area. Certain cities and states put a cap on interest rates. For example, Grice says that Massachusetts and Georgia have low interest rate caps and Utah has a very high cap.
If a shop owner is unsure whether or not a loan could be considered predatory, there are a few indicators to look out for. According to Rogers, predatory lending starts out with a friendly phone call or letter offering cash without the worry of regular payments. Basically, if an offer sounds too good to be true, it probably is. Rogers explains that in the most common instance of predatory lending, the lending companies will take a percentage of a shop’s daily credit card receipts as payment. While this percentage may not seem like a lot to shops, it can be crippling to the business. Rogers believes that many small business owners don’t know how much they actually make in a year after they’ve paid off everything that it costs to run the shop, Rogers explains, which is why the 8, 10, 12 percent that the lending companies take can be so detrimental to the health of the shop.
Another form of predatory lending is when a business takes out a loan and promises to repay it within a pay period. More often than not, businesses that take out loans like this are unable to pay back the loan within the short time frame, resulting in extremely high interest rates and growing debt. Grice says that although these type of hard money loans are extremely convenient to obtain, they should be avoided at all costs.
A Slippery Slope
People that take out predatory loans are usually in such a dire situation that they feel like they have no other choice, Rogers explains. There’s always another choice. Rogers has seen the repercussions of predatory loans and says that it’s almost impossible to get out of debt once a person starts down that path. People lose their businesses and their homes because of this type of lending. Rogers says he had one client who had to take out three loans in rapid succession just to stay afloat after falling for a phone call.
Obtain Financing in a Safer Way
Predatory loans look appealing and provide a quick fix, but Grice wants to make it clear that there are always other options for borrowing money. If a shop owner needs financing, Grice says the first step is to clearly identify what that financing will be used for, which requires good financial data. Before getting a loan, Grice advises shop owners to speak with their bookkeepers or accountants. Once the purpose is identified, Grice says shops should select who they want to partner with. Most small business owners should already have an established relationship with a bank. For those that don’t, Grice suggests getting recommendations and interviewing bank representatives to find someone who is familiar with the industry. After both of those steps are complete, the loan process can begin.
Both small and larger banks offer lending options for small businesses. Grice says that larger banks are a better option for a shop that has locations in multiple states and that small banks are an ideal option for small business owners. Creating a meaningful relationship with a banker is one of the smartest things a business owner can do, Grice says. One way to do that is to join a local chamber of commerce and meet a banker out of his or her element while working on something you both care about. Another great option is a credit union. Grice says that credit unions often have more flexibility than banks and can offer lines of credit and allow business owners to borrow money against a house with lower rates and fees than banks.
Even with all of these options, many still fall into the predatory loan trap. For shop owners that feel like they are being taken advantage of with extremely high interest rates or are being discriminated against based on factors like gender and ethnicity, Grice says there are organizations that will help.
The Federal Deposit Insurance Corporation (FCIC), the Federal Reserve, and the Consumer Financial Protection Bureau (CFPB) are all organizations that patrol banks and make sure rules are not being violated. Grice says that if a business owner feels that he or she is being taken advantage of to contact one of these organizations or a lawyer.