In October 2016, the Innovative Lending Platform Association, a consortium of OnDeck, Kabbage and CAN Capital, launched a model pricing and disclosure tool for borrowers in partnership with the Association for Enterprise Opportunity. The tool, called SMART (Straightforward Metrics Around Rate and Total Cost) Box, will display key metrics to help borrowers understand the financial impact of the loan they are considering. These metrics include the total repayment amount, expected loan term, repayment schedule, total cost of capital (TCC), annualized percentage rate (APR), average monthly payback and cents on the dollar cost of the loan.
SMART Box is a welcome change to the small business (SMB) online lending industry that has historically been opaque about the fees and costs associated with its products. Many lenders use different interest rates, such as factor rates or simple interest rates, to express the cost of a loan, and many times these rates do not include additional fees that a borrower will pay over the lifetime of the loan (e.g., origination fees, service fees, etc.). This lack of standardization and transparency across the industry makes it difficult for borrowers to make apples-to-apples comparisons of loan offers.
Banks have long used APRs for credit cards and loans to give a clear picture of the total cost of a product, including interest and associated fees. However, banks have been under much greater regulatory scrutiny through laws such as the Truth in Lending Act and the creation of the Consumer Financial Protection Bureau (CFPB) than many of the online SMB lenders. Thankfully, this will likely change as the CFPB will soon begin collecting data on small business lending practices and may decide to pursue regulation on the matter. The SMART Box tool is a great step in the right direction for the industry, but unless all alternative lenders adopt it, regulatory action may still be necessary to prevent predatory lending practices.
One main reason online lenders shy away from APRs is that they claim APRs may not accurately represent the total cost of their loan products, especially if a loan has terms of less than one year. This can be true in some circumstances, but some alternative lenders have much higher APRs than those offered by banks, and this sticker shock may be the real reason that alternative lenders frequently don’t use APRs.
APRs and other metrics, such as TCC, are important tools in helping borrowers understand just how much a loan will truly cost them. It should go without saying that if you don’t know how much you will pay back over the lifetime of the loan, then you should shop elsewhere. You should have a clear idea of how much you will pay in interest and fees on a loan before accepting any offer.
Other factors that you should consider when comparing lenders include terms and restrictions on the loans. Some lenders will offer loans with shorter terms and require daily or weekly repayment, which can be disruptive to a business’s working capital. Other lenders may not lend to businesses in certain industries (frequently financial services, gambling and nonprofits) or in specific states. Finally, some loans will come with restrictions on how the loan may be used. For example, some types of Small Business Administration (SBA) loans cannot be used to refinance existing debt or purchase real estate.